We talked about credit scores in another article. As we learn about credit and debit cards, an obvious question comes up: how do these cards impact my credit score?
Let’s start with debit cards. The short answer is that a debit card will not impact your credit score. A debit card is not a form of credit because you are only spending money in your own checking account. Accordingly, credit reporting agencies ignore debit cards when calculating your credit score.
Credit cards do have an impact on your credit score. If you spend within your limits and pay off your credit card bill in full every month, then a credit card is good for your credit score. If you spend over a certain threshold of your credit limit or miss credit card payments, then a credit card is bad for your credit score.
Interestingly, carrying a balance on your credit card – that is, not paying off the full amount owed in a given month – will not impact your credit score. However, this will start to accrue interest and increase the amount of money you owe.
What are the elements of a credit score?
As a brief review of our article on credit scores, there are several important factors that make up your credit score.
- Credit history: Have you missed any debt payments?
- Credit utilization: How much of your allowable credit do you use?
- Types of credit accounts used: Do you have different types of credit accounts?
- Length of credit history: Have you had credit accounts for a long time?
- Recent requests for credit: Have you applied for a lot of loans or credit cards recently?
How does opening a credit card account impact my credit score?
- Recent requests for credit: When you apply for a credit card, you trigger a “hard inquiry” of your credit report to check if you have a history of paying back your debts. Each hard inquiry slightly reduces your credit score, though the positive impacts of getting a credit card can offset this reduction.
- Length of credit history: When you get a new credit card, you add a credit account with an age of 0 years and 0 months to your credit report. Unless you don’t have any other forms of credit, this addition will reduce the average age of your credit accounts. Accordingly, getting a new credit card can reduce your credit score at first, though keeping the same credit card for a long time will increase your credit score as the average age of your accounts increases.
- Credit utilization: Your credit utilization is a simple fraction: how much money you spend using credit cards divided by the total of all your credit limits. If you spend $5,000 per month and your credit limit is $10,000, then your credit utilization is 50%. Your credit score will be higher if you have a lower utilization percentage. When you get a new credit card, the overall credit limit will increase. If your spending on credit cards does not change and the allowable amount of spending available increases, your utilization will decrease and credit score will increase.
- Types of credit accounts used: If you do not have any credit card accounts, then opening a credit card will diversify the types of accounts you have and increase your credit score. If you already have a credit card account, then opening a new account will not impact your credit score.
What happens to my credit score if I pay my credit card bill every month?
This one is simple: if you don’t miss any payments, then your credit score will increase.
At the same time, if you miss a payment – which means you don’t send in a payment for a specific month – then your credit history will reflect that missed payment. This will decrease your credit score.
How does closing a credit card impact your credit score?
When you no longer want a credit card, you can close the account. However, there are a few implications for your credit score:
- Length of credit history: If the credit card account that you are closing is older than the average age of your credit accounts, then closing the credit card account will decrease your credit score. If the account is younger than the average age of your credit accounts, then closing it may actually increase your credit score.
- Credit utilization: If your spending does not change, then closing a credit card account will reduce your credit limit and increase your credit utilization. When your credit utilization increases, your credit score will decrease.
