Here’s the dilemma. You’ve checked your free credit scores and found out that yours could be higher if you had a better “account mix.” But you’ve also heard that opening a new account can ding your credit scores. So how do you decide when opening new credit accounts is a good idea?
Read more: How to get your free credit score
How new accounts impact your credit score
That’s a question I recently heard from a consumer trying to raise her credit scores. Currently, she only has revolving accounts and has been advised that adding an installment account to the mix could help. But getting a new loan makes her nervous.
“If a credit score has a 10% component from new credit, and mix of credit is also a 10% contributing factor, do those two just end up canceling each other out, and thus a loan would not actually help improve my score?” she asked.
Fortunately, she’s not stuck. Adding an installment loan may help her credit scores over time. Although a new account may cause a dip in her scores, that should be temporary and her scores will likely bounce back after a few months’ payment history is reported on the new account. (If she pays on time, of course.)
Read more: How to improve your credit score
Other factors to consider before applying for new credit
There are other things she needs to watch out for. The “new credit” category includes inquiries, as well as new accounts.
An inquiry will almost certainly be created when she applies for a loan. But most lenders only pull one credit report to make a credit decision, so that inquiry is likely to only appear on one of her credit reports and shouldn’t affect all of her reports or scores.
And even if it does cause her credit score to drop, it should be minor. An inquiry generally only shaves a few points off credit scores—somewhere in the range of 2 to 7 points. If she applies with a bunch of different lenders, though, those multiple inquiries could really hurt her scores.
One thing she overlooked is the fact that new accounts can affect another credit score factor: the age of her credit history. A recently opened account shortens the average age of all accounts, so it’s important she not go overboard and open several new accounts.
Boosting your credit score
Over time, the credit score boost from the new loan will likely outweigh these shorter-term negatives. An installment loan paid on time over time can provide a beneficial credit reference and contribute positively to the mix of credit category. Any type of installment loan can help, including an auto loan, mortgage, student loan or even a personal loan (as long as it’s not a line of credit).
She definitely doesn’t want to throw away a lot of money on interest just to boost her scores by what may turn out to be a few points, so if she decides to go this route, she should look for a loan with a low interest rate and pay it off quickly.
More important credit score factors
Finally, the factors mentioned above are pretty minor when compared to payment history and debt. So the focus should always be first on paying on time and keeping balances on revolving accounts, like credit cards, low.
Getting out of debt can be one of the biggest credit score boosters around, and should be a top priority for improving credit.
Read more: How to start paying off credit card debt