How Do Credit Cards Affect Your Credit Score?
Credit cards are a significant factor in calculating your credit score. Whether you’re trying to build credit from scratch or bounce back from a low score, it’s important to understand how your credit card usage can help or hurt your efforts to establish a good credit score.
Understanding credit score basics
First, you need to know which components of your credit report are used to calculate your credit score. When you’re applying for a new credit card or loan, your credit score is a key piece of information lenders and credit card issuers will review to assess your creditworthiness. FICO and VantageScore are the primary credit score providers, and both use a credit report from one of the three major credit bureaus (Equifax, Experian, or TransUnion) in their credit scoring models. The five key factors they’re looking at are:
- Payment history (roughly 35% of your score): Making on-time payments can be the most important factor in determining your credit score. Missing or late payments reported by the credit bureaus can bring down your score.
- Outstanding debt (30%): Your current balances on credit accounts can also have a significant impact on your credit score. Your credit utilization ratio—the percentage of your available credit you’re using—is a key component of this scoring factor.
- Length of credit history (15%): This part of your score includes the age of your oldest account, the age of your newest account, and the average age of all your accounts. A longer, or “older,” credit history is considered better and can help your score.
- Credit mix (10%): Whether your credit history includes both installment and revolving credit accounts can have a relatively minor impact on your score. Only having one type of credit account on your credit report can lower your score.
- New credit (10%): Opening new accounts and having hard pulls on your credit report can lower your credit scores. However, this is a less important factor in your score and is often necessary if you want to build credit.
Note that while exact percentages used in a specific individual’s score calculation can vary, the relative importance of credit score factors tends to stay the same.
How opening a new credit card impacts your credit score
Opening a new credit card account can both help and hurt your credit score. Before you even start using a credit card, here’s what you need to know.
Improving your credit utilization ratio
Opening a new card will increase your total credit limit across all of your cards.
If your spending stays the same, this will lower your credit utilization ratio which could help your score.
For example, if you have one credit card with a $1,000 limit that has a balance of $500, your utilization ratio would be 50%. If you open a second credit card that also has a credit limit of $1,000, and maintain a total balance of $500 across the two cards, your utilization ratio will reduce to 25%. Many credit experts recommend keeping this ratio below 30%, so this could have a positive impact on your credit score.
Adding to your mix of credit
If your credit history is limited to installment loans like student, personal, or car loans, adding your first credit card can demonstrate your ability to manage more than one type of credit. This added diversity in credit could have a positive impact on your score. But if your credit report already includes credit cards, adding one more is not likely to have much of an impact.
Ding to your score because of a hard pull
Opening a new credit card—or applying for a card regardless of whether you’re approved—requires a hard inquiry on your credit report. A hard inquiry, or hard pull, can lead to a slight drop in your credit score for up to a year. Opening one new credit card might be worth a small dip in your score, but applying for or opening several credit cards in a short period of time could have an undesirable impact.
That’s why Ava uses soft credit checks for the Credit Builder Card and Savings Builder. Applying won’t affect your credit scores, but using the accounts and making your payments on time can help you build credit and improve your credit score.
Bringing down the average age of your accounts
When you open a new credit card, this reduces the average age of your credit accounts and sets a new, lower age for your newest credit account. If you have few credit cards, this shift will have a bigger impact on your credit score than if you have many cards already open.
Four ways using a credit card can affect your credit score
Once you’ve opened a new credit card, how you use it can also impact your credit score.
Establishing a record of on-time payments
If you’re trying to build credit, a track record of consistent, timely payments is one of the best ways to boost your score. Whether you’re using a new or old credit card, staying on top of your monthly payments can help improve your score.
Demonstrating active credit usage
The length of credit history factor in your credit score also takes into consideration how long it has been since you’ve used specific accounts. Regularly using a credit card—even just for one small, recurring payment a month—can help you build your credit history.
Increasing your chances of missing a payment
While a credit card can help you improve your track record for on-time payments, it can also lead to more missed payments if you aren’t staying on top of a new account. Late payments can remain on your credit report for seven years, so it’s important to avoid delayed or skipped payments. Consider setting up automatic payments on or before the due date to avoid this long-term hit to your score.
Racking up a high balance (and utilization ratio)
If you don’t pay your monthly bill in full, your balance will steadily creep up. This results in a higher credit utilization ratio which can have a negative impact on your credit score. Paying more than the minimum payment can help you chip away at higher balances and reduce what you’re paying in interest.
How does closing your credit card impact your credit score?
Technically, the act of closing a credit card account doesn’t have a direct impact on your credit score, but getting rid of a card can influence other factors that affect your score.
Reducing the temptation to spend beyond your means
While your FICO score or VantageScore doesn’t explicitly take into account whether you’re spending responsibly, charging more than you can afford can impact other credit score factors. If closing a card will empower you to reduce overspending and make more on-time payments to other accounts, it could help your credit score in the long run. Be aware that closing an account doesn’t mean your credit card debt will disappear, you’ll need to pay off the card or do a balance transfer before closing it.
Decreasing the amount of credit you have available
In the same way that opening a new card can improve your credit utilization rate, closing a card can negatively affect this ratio and hurt your score. Once you cancel a card, your available credit will be reduced by the credit limit on that card.
Pulling down the average age of your accounts
When you close an account that's in good standing (you're not behind on payments), it can stay in your credit report for up to 10 years. The account's payment history and age may help your credit scores the entire time, but once the account falls off your credit report, it no longer affects your credit scores. Late payments can also continue hurting your credit score after the account is closed, but these fall off your credit report seven years after the late payment occurred, even if the rest of the account stays in your report.
While the ins and outs of credit scores can be complicated, the basics of achieving a good credit score are fairly straightforward: maintain at least one active credit card, make your payments on time, and avoid racking up high credit card balances. If you want to do this without taking on lots of debt, consider applying for a Credit Builder Card or Savings Builder loan. Improving your credit score is within reach with Ava.