Have you ever seen an unexpected drop in your credit score? And then freaked out, maybe just a little?
If you opened new credit, then your credit score will likely go down. This is TEMPORARY. I’ll explain…
- Opening a new credit card
If you open a new credit card, expect your score to drop 10 to 40 points temporarily. The reason for the drop is that the credit bureaus do not yet know how you will handle this new credit. Will you max out your card and go into more debt than your budget can handle? Will you pay the bill in full or will you carry a balance, thereby indicating that you are overspending? Will you pay on time, as agreed?
What to do next: Handle the new account like a pro. Pay the bill in full on time each month. Never charge more than 10% to 30% of the limit. Then don’t worry, because in about 3-4 months, the temporary score penalty will be lifted. At this point, your score will likely go higher than ever, because you have more available credit with a low usage rate — and all paid on time.
If you needed the additional credit because your credit file was too thin (only one account), then you have done the right thing by adding an account to your credit profile. Building good credit takes some time and everyone has to start somewhere.
- Opening a new installment loan
If you needed transportation and it was time for you to get an auto loan, then you have a new installment loan. An installment loan has a set ending date, unlike a revolving credit card that is open indefinitely. Depending on your credit profile, a temporarily score drop sometimes occurs. However, you will not be penalized for having a high balance-to-limit ratio with an installment loan, because that is the nature of a new loan of this type.
What to do next: set yourself up for auto-pay or pay your bill as soon as it comes in each month. Don’t set it aside and forget the date. Even with auto-pay, keep a watch to make sure the payment went through on time and was not delayed due to a holiday or due to being sold to another finance company.
An installment loan often raises a credit score, because it creates a more complex mix of credit, as opposed to having only a couple revolving credit card accounts. However, this is not an excuse to go out and buy a car or truck that you cannot really afford. Do not buy at the top of your budget. Be smart and keep your debt-to-income ratio low so that you can handle unexpected situations that require money outside of your normal budget.
In addition, do not buy a new vehicle if you plan to buy a house within the next year. Remember: buy the house first, then the car later. Doing it backwards is one of the worst mistakes people make, because the new auto loan then prevents them from getting approved for the home loan.
“House first, car later.” No exceptions!
One Last Word of Credit Advice
Do not obsessively watch your credit score. There is no point in making yourself crazy with micro-managing your score on a daily or weekly basis. If you Build and Protect Your Credit Like the Pros, then your score will reflect that. I have seen a young person’s score go from nothing to over 700 in six months, simply by following good strategy.
If you know someone who might benefit from this information, please share on social media and/or pass it on.