Will I hurt my credit score if I apply for credit cards?
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UPDATED: Nov 12, 2013
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A consumer’s credit score is greatly impacted not just by the amount of credit cards they apply for but also the time frame in which they apply for them.
Eric Adamowsky, Co-Founder of Credit Card Insider, said filling out multiple credit card applications in a short period of time will result in multiple hard inquiries within that short period. These inquiries cause consumer credit scores to fall.
“A hard inquiry occurs, when a lender pulls a copy of an individuals credit report or score,” he said. “Depending on the number of hard inquiries on the consumers report, an application may cause the consumers credit score to drop a handful of points if they have too many recent inquiries. If they have had little to no inquiries within the last two years, there should not be an affect on their score.”
The reason why hard inquiries are bad is because they raise a red flag in lenders’ eyes.
“Lenders tend to look at multiple inquiries for credit cards as a signal that an individual may be credit hunting because of a financial crunch, not because they are looking for the best deal for themselves,” said Cathyann Frank, Vice President of Operations at McGraw-Hill Federal Credit Union.
Credit scores also change as a borrower uses a credit card more and more, which affects a consumer’s credit utilization ratio. A credit utilization ratio is the amount of debt relative to the total available credit. As the credit utilization ratio of a card increases, that user’s credit score will fall.
For example, a consumer with $9,000 in debt on a $10,000 credit card will have a credit utilization factor of 90 percent. This level of debt compared to the available line of credit does not reflect well on the card holder.
Darrell Hornbacher, President of the Midas Financial Company, said that the ideal maximum ratio for borrowers is 27 percent. Other experts, however, are more conservative with what they feel is a healthy utilization ratio. Adamowsky says that lenders like to see utilization at 15 to 20 percent or below.
Regardless of where that threshold is, though, one thing is for certain: the higher that ratio is, the worse it is for consumers.
“Once the credit bureaus see your ratio exceed 40 percent they will knock off a few points from your score,” said Hornbacher. “They do the same at 50 percent, 60 percent, 70 percent, and so on.”
Lenders use this analysis against each individual card that an applicant has. A person with a credit utilization ratio of 75 percent on 5 different cards is likely to see their credit scores go down a hundred points. In Hornbacher’s estimation, this disqualifies them from getting an additional credit card, if not other types of financing.
Beyond applying for and using credit cards, another related metric can affect a consumer’s credit score: timing.
Consumers need think about timing when considering filling out a credit card application.
Rob Griffin, Director of Public Education for Experian, said that a person’s unique credit history really determines how far apart they should space credit card applications.
“As few as two or three accounts within a month’s time can be ‘too many’ if a person has had difficulty in managing their previous debts,” he said. “If they have a strong credit history, they may have little difficulty in applying for new credit within a short time.”
How do Credit Cards Work?
Credit cards are very similar to personal loans. Both provide lent money that is available to use at a borrower’s discretion. However, there are some differences between the two.
A credit card is a line of credit that can be used, then paid off, and then used once more.
For example, a cardholder can use $2,000 in a $4,000 credit card. They can then pay off $1,000, giving them a total available line of credit of $3,000.
However, a borrower who has a personal loan of $4,000 and spends $2,000 cannot just pay back some money to access more money once again. Money used up in a personal loan is simply spent and if a borrower wants more then he or she will have to apply for another personal loan.
This key difference is one of the reasons that credit cards are both more convenient and more popular than personal loans, in addition to the benefits that come from responsibly used credit cards.
“Responsible use of credit cards will improve a consumer’s credit score so that ultimately they will get the best rates on mortgages, and other types of loans,” said Adamowsky. “Consumers with excellent credit will typically pay far less in fees and interest points over their lifetime.”
Despite the fear of teenage spending sprees, credit cards are a tool that can build the credit of consumers who are becoming young adults. Responsible use of credit cards can create and improve credit scores, which in turn leads to better interest rates on home loans, car loans, personal loans, and other types of financing in the future.
Consumers should still use caution when trying to obtain these benefits and they should not rush out to apply for several cards or they risk suffering from hard inquiries.
With all of this talk of hard inquiries, a consumer’s natural reaction may be to close some of their existing cards, but that’s not always a wise choice since this can damage a credit score by changing the ratio of available credit to outstanding debt.
But for those in the credit card market, Frank urges consumers to shop for credit card deals, such as rewards cards with points that never expire or those that give cash back benefits. These perks can help borrowers pay their credit card balance down and act as “icing on the cake,” so to speak.