Does Applying for Credit Hurt Credit Scores?
Money Girl answers reader questions to clear up common misunderstandings about applying for credit and changing your credit limits.
Laura Adams, MBA
Listen
Does Applying for Credit Hurt Credit Scores?
Just about every aspect of personal finance can be confusing. But if I had to pick one that seems to leave people scratching their heads the most, it would be credit.
There are some common misunderstandings about what happens to credit scores when you apply for new credit or have an existing credit limit changed. In this episode I’ll clear up any confusion by answering reader questions and tell you what you need to know to maintain excellent credit for life..
Click here to subscribe to the weekly Money Girl audio podcast—it’s FREE!
What Is a Credit Score?
If you’re a regular Money Girl reader or podcast listener, I bet you already know a lot about credit. But if you’re new to the subject, here’s a quick primer:
· Your credit report is a history of your credit accounts and payment activity. It also includes your basic personal information and certain types of public data, like whether you’ve declared bankruptcy or are involved in a lawsuit.
You’re legally entitled to a copy of your credit report from each of the 3 nationwide credit agencies once a year at annualcreditreport.com. Although it’s full of important information that you should review for accuracy at least every 12 months, don’t expect to see your credit score.
· Your credit score is a rating that quantifies the potential risk you pose to a lender or merchant. The higher your score, the less risky you appear. There are hundreds of different credit scoring models in use today, each with its own scale and mathematical formula. A variety of companies, including the credit agencies, sell credit scores to consumers, lenders, and merchants.
Why Credit Scores Are Important
Your credit score is important because having poor credit is expensive. But don’t fall into the trap of thinking that credit only matters if you’re applying for a mortgage or a car loan. Many people who don’t like the idea of having debt seem to discredit credit and say that it’s insignificant.
It’s true that you’ll pay much higher interest rates for loans and credit cards if you don’t have excellent credit. For instance, poor credit could cost you a whopping $70,000 in additional interest on a $200,000, 30-year mortgage!
However, your credit also affects your finances in many less obvious ways that are unrelated to debt…
For instance, having good credit means you’ll pay less for insurance on your car and home (except in California, Massachusetts, and Hawaii, where it can’t be a factor in setting rates). If you don’t own a home, your credit typically is a factor in getting approved to rent an apartment or home.
Credit also plays a big role in utilities, such as water, power, gas, cable, and wireless service. Applying for these services is applying for credit—so having poor credit makes it difficult to get them. You might have to pay a hefty security deposit, get someone with good credit to co-sign your application, or get a letter of guarantee from someone that says they’ll pay your utility bill if you don’t.
And if I haven’t already made my point that having good credit can save you money, did you know that it can also help you earn more? Many employers check prospective employees’ credit reports before making hiring decisions. You could get turned down for your dream job if you have a credit report that makes you appear irresponsible with money.
What Happens to Credit Scores When You Apply for Credit
I received this email from Alex:
“I’m 23 years old and only have one credit card. I recently went shopping for engagement rings and the salesperson offered to check into how much I could finance. Yesterday, to my surprise, a store credit card with my name showed up in the mail. I don’t want the card. Is there a way to reverse the application as if it never happened, so it won’t hurt my credit?”
This is a really common predicament. Many consumers get talked into applying for credit cards that they don’t want—or think that they’re just signing up for a store promotion. Never give any personal information to a store clerk unless you intend to apply for a new credit account.
Did you know that having good credit can also help you earn more?
Unfortunately, there’s no way to reverse a credit application. Even if you cancel a new credit card quickly, it still shows up as an inquiry and credit account on your credit history. But the good news is that inquiries have a minimal impact on credit scores and the negative effect decreases quickly over time.
What Happens to Credit Scores When You Change Credit Limits
Here’s another question that I received from listener Michelle:
“I recently requested a credit limit increase on one of my credit cards. I always pay them off in full each month and have excellent credit. But now I’m worried that my request will end up hurting my credit score.”
You might be surprised to know that increasing credit limits can only increase your credit scores. That’s because your balance-to-limit ratio, known as your utilization ratio, is an important factor in how most credit scores are calculated. It’s simply a comparison of your total balances on credit cards and lines of credit to your total credit limits.
Lowering credit limits or closing a credit account causes your utilization ratio to increase, which typically hurts your credit. However, if you’re like Alex and want to close a new account quickly, the net effect of opening it and closing it should be a wash on your utilization ratio.
To maintain excellent credit for life, focus on what you can control by following these Quick and Dirty Tips:
· Pay all of your credit accounts and bills on time
· Maintain a utilization ratio that never exceeds 20%
· Use credit accounts, but never take on more debt than you can afford
· Have one or two credit cards that you use on a regular basis and pay off in full each month
· Check your credit report for errors that may be dragging down your scores
Get More Money Girl!
There’s a huge archive of past articles and podcasts if you type in what you want to learn about in the search bar at the top of the page. Here are all the many places you can connect with me, learn more about personal finance, and ask your money question:
- Google+
- Money Girl podcast on iTunes (it’s free to subscribe!)
- Email: money@quickanddirtytips.comcreate new email“>money@quickanddirtytips.comcreate new email
Click here to sign up for the free Money Girl Newsletter!
Download FREE chapters of Money Girl’s Smart Moves to Grow Rich
To learn about how to get out of debt, save money, and build wealth, get a copy of my book Money Girl’s Smart Moves to Grow Rich. It tells you what you need to know about money without bogging you down with what you don’t. It’s available at your favorite book store in print or as an e-book for your Kindle, Nook, iPad, PC, Mac, or smart phone. You can even download 2 free book chapters at SmartMovesToGrowRich.com!
About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.