Jack Prenter, Founder of Dollarwise
A credit score is a numerical representation of your creditworthiness, used by lenders to determine the risk of lending to you. It affects your ability to get the best credit cards, loans, and even impacts the interest rates offered to you.
Whether you’re applying for your first credit card or managing multiple lines of credit, a solid grasp of how your credit score is impacted by applications, is critical.
Does applying for a credit card impact your credit score?
When you apply for a credit card in Canada, the lender conducts what is known as a ‘hard pull’, ‘hard inquiry’, or ‘hard check’ on your credit report. This is a thorough credit check to assess your creditworthiness. Here’s how it impacts your credit score:
- Hard Pulls: Each hard pull can slightly lower your credit score. This happens because applying for new credit suggests you might be taking on more financial risk. While the impact is typically small, multiple hard inquiries in a short period can add up.
As such, the effect of applying for a credit card on your credit score can be viewed in two timeframes:
- Short-term Impact: Initially, a hard check may reduce your score by a few points. However, this effect is usually minor and temporary, lasting for about a year.
- Long-term Impact: Over time, if managed responsibly, a new credit card can actually improve your credit score. It can help by improving your credit utilization ratio and adding to your credit mix, provided you make payments on time.
The exact number of points your score drops due to a hard pull can vary. On average, you might see a 5 to 10 point reduction. However, this varies based on your individual credit history.
It’s essential to balance the short-term impact of a slight score decrease with the potential long-term benefits of responsibly managing a new credit card. While the immediate effect might be a small dip in your score, the long-term advantages of diversified credit and improved utilization can outweigh the initial impact.
Factors influencing the impact
The impact of applying for a credit card on your credit score isn’t uniform; it varies greatly based on individual credit histories and existing credit scores.
Impact based on credit history:
- Lengthy Credit History: If you have a long and robust credit history, a new credit check may have a less significant impact. Your history has already established your credit behavior over time, so one additional inquiry might not sway the overall picture much.
- Short or Limited Credit History: For those with a shorter credit history or fewer credit accounts, a hard pull can have a more pronounced effect. Since there’s less information to assess your creditworthiness, a new inquiry can form a more significant part of your credit report.
Impact based on existing credit scores:
- High Credit Scores: Individuals with high credit scores might see a smaller dip from a hard pull. A high score indicates a history of responsible credit management, so lenders might view an additional credit application as less risky, especially if you’ve been paying your debt off on time.
- Lower Credit Scores: Conversely, if your credit score is on the lower end, the impact of a new credit inquiry can be more substantial. This is because a lower score suggests higher risk to lenders, and adding another credit application could be seen as increasing that risk.
What is a credit score?
A credit score in Canada is a three-digit number that acts as a snapshot of your financial reliability and health. It’s a tool lenders use to quickly assess how likely you are to repay borrowed money. This score ranges typically from 300 to 900, with higher numbers indicating better credit health.
The calculation of a credit score in Canada revolves around five key factors:
- Payment History (35%): This is the record of how consistently you make payments on time. Late or missed payments negatively affect your score.
- Credit Utilization (30%): Credit utilization refers to the amount of credit you’re using compared to your total available credit. Keeping this ratio low is beneficial.
- Credit History Length (15%): Longer credit history provides more data on your financial behavior and usually benefits your score.
- New Credit Inquiries (10%): Every time a lender checks your credit score, it can slightly lower your score. This is typically a small and temporary effect (5-10 credit points).
- Types of Credit Used (10%): This reflects the mix of different types of credit, like credit cards, lines of credit, or loans, you have.
Each of these components plays a role in determining your overall credit score. It’s important to understand that this score is fluid, changing with your financial behaviors. Regularly checking your credit report is a good habit, as it allows you to keep track of your score and understand where you stand in terms of credit health.
Remember, a strong credit new credit cardcan open doors to better interest rates and more favorable credit terms.
Managing credit utilization
Tips for credit scoring
Typically, it’s advised to keep your credit utilization below 30% of your total available credit. This threshold is seen as a marker of good credit management.
Tips for managing credit utilization
- Monitor Your Balances: Keep a close eye on your credit card balances. Even if you pay off your bills in full each month, knowing your running total can help you stay within the ideal utilization range.
- Increase Your Credit Limit: If you’re eligible, consider requesting a higher credit limit on your existing cards. A higher limit, if not accompanied by increased spending, can lower your overall utilization ratio.
- Spread Out Your Charges: If you have multiple credit cards, spreading your charges can help manage the utilization on each card. Avoid maxing out a single card while others have low balances.
- Pay Bills More Than Once a Month: Making multiple payments throughout the billing cycle can keep your balances lower, reducing your utilization ratio.
- Be Mindful with New Cards: When getting a new credit card, consider how it affects your total available credit. A new card can increase your total credit limit, thus potentially lowering your overall utilization if you maintain or reduce your total balances.
Effectively managing your credit utilization is not just about reducing the amount you owe but also about understanding and strategically using your total available credit.
By keeping your utilization low and demonstrating responsible credit use, you can positively influence your credit score.
Strategies before applying for a new credit card
Applying for a new credit card should be a well-considered decision. To enhance your chances of approval and minimize any negative impact on your credit score, it’s important to employ strategic planning. Here are key strategies to consider:
Researching eligibility and chances of approval:
- Know Your Credit Score: Before applying, check your current credit score. This gives you an idea of which credit cards you’re likely to be eligible for.
- Understand Card Requirements: Different cards have different requirements. Look for cards that match your credit profile to increase your chances of approval.
- Consider Your Financial Situation: Assess your income, existing debt, and financial stability. Lenders will consider these factors, so applying for a card that aligns with your financial status is crucial.
Timing of applications:
- Space Out Applications: Applying for multiple credit cards in a short period can signal risk to lenders and impact your credit score. Space out your applications to minimize this effect.
- Plan Around Big Loans: If you’re planning to take out a significant loan, like a mortgage or car loan, it’s wise to avoid applying for new credit cards beforehand. Lenders for large loans might view recent credit applications as increased financial risk.
- Seasonal Considerations: Sometimes, credit card companies offer special promotions or better terms at certain times of the year. Keeping an eye out for these can be advantageous.
Tips for building and maintaining a healthy credit score
Building and maintaining a healthy credit score is a key component of financial well-being. Two fundamental strategies are crucial in this regard: making consistent, on-time payments and effectively managing multiple lines of credit (if you have them).
Consistent, On-time payments
- Set Payment Reminders: Establishing reminders before your payment due dates can help ensure you never miss a payment.
- Automate Payments: Consider setting up automatic payments for at least the minimum amount due. This can prevent accidental missed payments.
- Budget for Payments: Adjust your monthly budget to prioritize debt payments. Timely payment of bills, including credit cards, loans, and utilities, is essential for maintaining a good credit score.
Managing multiple lines of credit
- Understand Each Account: Be aware of the terms, interest rates, and credit limits of each line of credit you hold. This knowledge helps in utilizing each credit source effectively.
- Keep a Healthy Mix: A diverse mix of credit types, such as installment loans, retail accounts, and credit cards, can positively impact your score. However, this doesn’t mean you should acquire more credit than you can handle.
- Monitor Credit Utilization: Aim to keep the credit utilization ratio low on each line of credit. High balances can negatively impact your score.
- Regularly Review Your Credit Reports: Check your credit reports from various bureaus regularly for inaccuracies. Dispute any errors you find, as these can affect your score.
Building a healthy credit score doesn’t happen overnight. It requires a consistent effort to manage your finances responsibly. By making timely payments and wisely handling various credit accounts, you can steadily improve and maintain your credit score.