New credit: A small but important credit score factor

New credit can make you seem risky to lenders, but don’t fear new accounts

By  and   |  Updated: October 12, 2017

How your FICO credit score is calculated: New credit

If you’re not careful, taking on too much new credit too quickly can hurt your FICO credit score.

However, adding some “new credit” to an old, troubled account may actually help your score by decreasing your credit utilization ratio

Confused? Welcome to the complex world of the FICO credit score.

That score is used by lenders to decide whether to extend credit to a potential borrower and at what terms. In calculating the score, FICO looks at, among other things, loan applications and new debts that were added to a credit report in the past six to 12 months. It isn’t the biggest factor, but the appearance of “new credit” does influence a consumer’s FICO score. In FICO’s view, it makes a borrower riskier, and thus will typically have a short-term damaging effect on their FICO score.  

But new credit can also help your score by lowering your overall credit utilization. For example, let’s say you own one credit card with a $5,000 limit and a balance of $4,000. Your credit utilization ratio is a whopping 80 percent – sure to be viewed as risky to potential lenders. However, if you’re able to get a new card with a $10,000 limit and you don’t use it right away, your credit utilization falls to a more palatable 27 percent.

New credit can help or hurt your score – it all depends on what else is in your credit history and how you plan to use the new accounts. 

 “In general, it’s best to be conservative when applying for new credit,” said Rod Griffin, director of public education at Experian. “However, this doesn’t mean you should be afraid to open a new account.”

Where new credit fits in
Because of the score’s widespread use, what matters to FICO should also matter to you. And what matters to FICO are five separate factors:

1.       Your payment history.
2.       Your credit utilization.
3.       How long you’ve had credit.
4.       How much new credit you have.
5.       What types of credit you have.

“New credit” makes up about 10 percent of a consumer’s FICO score, which ranges between 300 (poor credit) and 850 (excellent credit). 

While building a long history of responsible borrowing will eventually lead to a high FICO credit score, getting a new loan or even just applying for a loan can hurt your score. FICO says its research has shown that borrowers who have recently taken on new debt are more likely to become delinquent or miss loan repayments than borrowers who have not opened new accounts. As a result, FICO’s scoring model treats new accounts as having a temporary negative effect upon your FICO score. 

How negative? It depends on the length and breadth of your credit history. However, the scoring impact of opening one new account should be the same for any type of loan, whether it’s a car loan, a credit card or something else.

NEW CREDIT COMPONENTS

Within its new credit category, FICO considers the following factors:

  1. How many accounts have been opened in the past six to 12 months, as well as the proportion of accounts that are new, by account type.
  2. How many credit inquiries have been made recently.
  3. How long it's been since the opening of any new accounts, by account type.
  4. How long it's been since any credit inquiries.
  5. The re-appearance on a credit report of positive credit information for an account that had earlier payment problems.
NEW CREDIT COMPONENTS

Within its new credit category, FICO considers the following factors:

  1. How many accounts have been opened in the past six to 12 months, as well as the proportion of accounts that are new, by account type.
  2. How many credit inquiries have been made recently.
  3. How long it's been since the opening of any new accounts, by account type.
  4. How long it's been since any credit inquiries.
  5. The re-appearance on a credit report of positive credit information for an account that had earlier payment problems.

As the above table shows, the first decline in a FICO score happens before a new account is even opened. When you apply for a loan, it results in what’s called a “hard” credit inquiry, which happens when a bank checks your credit history to decide if it should approve the credit card or loan. (That’s different from a “soft” inquiry, such as when you check your own credit report.) Only hard inquiries negatively impact a borrower’s score.

Just how much damage does a hard inquiry do? For most people, it amounts to a loss of fewer than five points and inquiries fall off your report after two years. But it can vary.

“For example, inquiries can have a greater impact for someone with a short credit history and few accounts than for someone with a long history and a wide range of credit experience,” said Barry Paperno, a credit scoring expert who has worked at FICO and Experian.

Multiple credit inquiries over a short time frame – such as applying for five credit cards within a week – can multiply the score damage. However, with other types of new credit, FICO recognizes that borrowers typically shop around.

That’s why inquiries from multiple mortgage, auto and student loan applications won’t hurt your score for 30 days. Once a month has passed, the FICO scoring model treats multiple inquiries for one of those loan types as a single inquiry, provided the applications all took place within a relatively short window of time, such as 45 days. That consolidation of inquiries helps limit the FICO score damage that would otherwise be caused by multiple credit checks, each counted individually.    

For other types of accounts, it isn’t only the inquiry that hurts: Some new accounts hit a borrower’s score more than once. Paperno explains that for credit cards and charge cards, the initial inquiry can lower a FICO score and, once approved, the actual appearance of the account on a credit report can hurt it again.

Why that double penalty? Both items are “predictive of future risk, as it indicates the consumer is seeking new credit. The same can also be said about the appearance of a new account without an inquiry on the credit report,” Paperno said. “The FICO scoring formula is designed to assess risk by considering all information on the credit report, even if multiple pieces of information are pointing to the same action by the consumer.”

"Inquiries can have a greater impact for someone with a short credit history and few accounts than for someone with along history and a wide range of credit experience."

‘Born again’ new credit
To make things a little more complicated, in FICO’s eyes, new credit isn’t all bad: Recent “catch-up” payments for older delinquent accounts are treated as new credit and are positive for your score, while the careful use of new loan accounts can help reduce the scoring impact from any past borrowing mistakes.

Under FICO’s formula, the “re-establishment” of positive credit information – which takes place when a borrower becomes current on previously past-due accounts – is viewed positively. Over time, as the months pass and the borrower makes additional on-time payments, the borrower’s FICO score will continue to heal from past mistakes.

However, since some older delinquent accounts may have already been closed, it’s not always possible to get current on those troubled accounts. In those situations, FICO says simply adding new accounts – and always paying them on time – can help to rejuvenate the borrower’s FICO score, since they demonstrate the borrower is now acting more responsibly. And although the initial hard inquiry may cause a score dip, a responsible borrower can expect to regain any lost points after a year.

“As long as the new account is managed responsibly, you should see your credit scores come back once your credit history stabilizes,” Experian’s Griffin said.

Carefully add new credit
FICO encourages borrowers to only open loan accounts they actually need. Credit counselors agree that taking on too many new accounts can cause problems. That’s why they advise borrowers against recklessly applying for new credit cards.

But the fear of taking on new credit can be overblown. Besides, since new credit accounts for just 10 percent of a borrower’s FICO score, and a careful application process can limit the scoring damage, borrowers should focus on improving other aspects of their behavior rather than worrying about opening new accounts.  

See related: Applying for multiple credit cards at the same time is a bad idea, With two $0 balance cards, will a new card hurt my score? 


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Updated: 10-20-2017

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