How Applying for New Credit Affects Your Credit Score
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If you have ever opened a cell phone account with a monthly plan, applied for a credit card or secured a loan, you have a credit report. If you’ve had open accounts for several months, you’ll have a credit score too. Many Canadians have never paid a lot of attention to their credit score and many don’t even know why it is important. If you’re one of these Canadians, then this article is for you.
There are two credit reporting bureaus in Canada, Equifax and TransUnion. Creditors regularly report to one or both bureaus, also called Consumer Reporting Agencies (CRAs), regarding the credit products that you use and how responsibly you use them.
If you are applying for a mortgage or other credit products, lenders look at your score to determine your creditworthiness. Employers, potential landlords, and insurance companies also have the right to pull your credit report, before approving your application.
You can contact Equifax or TransUnion, to view your own credit report and credit score. It’s a good idea to check both companies annually because each receives slightly different information from your creditors. By keeping an eye on your credit history, you can spot and correct errors or potentially fraudulent behaviour that could hurt your credit score.
Want to know how the length of your credit history affects your credit score? Find out here.
Factors That Can Affect Your Credit Score
The CRAs keep records of your personal information, past and current credit accounts, and your payment history. They use this information to calculate and assign each person a credit score that lenders can use to help them determine whether you are a good credit risk. Your credit score is calculated by considering five main factors, with each factor being given a specific weight.
Payment History (35%) – Have you always paid your accounts on time? Do you have any missed or past due payments in your history? Have you ever filed for bankruptcy or filed a consumer proposal? These records will help lenders predict your future payment behaviour. If your behaviour poses a risk to future lenders, your credit score will definitely be lower. If you always pay on time, your score will be higher.
Current Debts (30%) – How much debt are you currently carrying? How much credit do you have available to you? Lenders will look at these amounts to determine if you be able to manage the amount of credit you are applying for. Keeping your usage under 30-35% of your limit will help keep your score healthy.
Account History (15%) – How old are your credit accounts? Do you have a mix of older and newer products in your file? Creditors like to see that you have been able to manage credit over time. The higher the average age of your accounts, the better the impact on your credit score.
Number of Inquiries (10%) – How often are you applying for new products? Too many recent hits on your file, especially in the last year, may lower your credit score and may be a red flag for lenders.
Types of Accounts (10%) – Do you have a mix of credit accounts on your credit file? Lenders like to see that you can handle revolving and installment credit, so a variety of accounts will affect your credit score in a positive way.
Click here for an in-depth look at how your credit score is calculated.
What is Your Credit Score?
The credit bureaus use the information in your file to calculate your credit score, usually between 300-900:
- Terrible (less than 500)
- Very Poor (500-579)
- Poor (580-619)
- Fair (620-679)
- Good (680-719)
- Very Good (720-779)
- Excellent (780+)
If you have a very low score, you’ve probably had some difficulties in your credit history, such as a delinquent account or bankruptcy, and you may have a tough time getting approved for new credit. If you have a top score, lenders will see that you pay your bills on time, all the time and will be more likely to lend you the money you want.
To learn more about credit score ranges, click here.
How Applying for New Credit Affects Your Credit Score
Each time you apply for a new credit account (including cellular phone plans), your information is reported to one or both the credit bureaus and this information will show up on your credit report. If you have too many hard inquiries on your account, your credit score may suffer and that could cause lenders to think you are in financial trouble and might prevent you from getting the money you need, so it is important to obtain new credit only when you need it.
Not All Credit Checks Are Equal
- Hard Inquiries – Hard pulls usually come from financial institutions where you have applied for a financial product or service and have given the company permission to see your file. A single inquiry may have a small effect on your credit score. Usually one hard pull this isn’t a big deal but if you experience several hard pulls within a short period of time, you may experience a bigger problem. Your score may be reduced significantly and enders may worry that you are living beyond your means.
- Soft Inquiries – Soft pulls do not require your permission. Often, they come from sources, other than lenders, who are doing background checks. These might include potential employers, insurance brokers, and car rental companies. Credit card companies may also review your files when offering new cards or increased credit limits. Soft inquiries won’t be seen by most lenders and won’t affect your credit score.
It’s always a good idea to ask what type of inquiry they will be doing before giving anyone permission to run a credit check on you. When you request your own credit report and/or credit score, it is considered a soft pull and will not affect your credit score or your ability to be approved for a credit product in the future.
If you are planning to purchase a home or vehicle, you might worry that shopping around for the best mortgage or loan will hurt your credit score. No need, just keep your shopping inside a two-week period and your inquiries will be counted as a single hit.
For more information about credit inquiries, look here.
Will Opening a New Credit Card Hurt My Score?
The short answer is, it could. A new credit card could lower the average age of your accounts, especially if you close an older account first. Also, if you use it immediately, it could increase the amount of debt you have. Always consider all the benefits and drawbacks before applying for a new credit card.
On the other hand, if your credit file is new, it could help you start building your credit and increasing your credit score. A credit card could be a benefit if you’ve only had installment loans before. Lenders like to see that you can manage different types of credit in your file. The key is to use credit wisely and pay it back as agreed.
Click here to find out if paying off your credit card bills will increase your credit score.
What if I’ve Had Too Many Inquiries?
Don’t stress if too many credit inquiries have reduced your credit score. This factor carries less weight than others when calculating your overall score. Though credit inquiries may stay in your file 3-6 years, depending on the credit bureau, their impact on your credit score lessens with time. From now on, limit your credit applications to those that are essential and your score will creep back up over time.
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Margaret Johnson is in the business of helping Canadians tackle their debt, deal with credit issues, and regain control of their finances.