New financing does have an impact on your credit score. It can help you improve your credit score as well as harm it.
Let us discuss how new financing affects your credit score and which factors are critical for you.
Does Financing Affect Your Credit Score?
New credit financing does affect your credit score. It may have a positive or negative impact as several factors count towards your credit score.
Even when you do not qualify for a new loan, you may see a drop in your credit score due to several hard inquiries.
When you are utilizing the loan or credit amount previously unutilized, it does not account for new financing. It will not have an impact on your credit score unless it drastically changes your total credit utilization rate.
New credit is only when you apply for a new loan or mortgage. For example, if you apply for a new credit card, a new home line of equity, or a new auto loan, it will be considered new financing.
Now let us consider two scenarios where new financing can affect your credit score.
When Does it Increase Your Credit Score?
If you apply for a new credit type that you didn’t have previously, it will improve your credit mix. Your credit mix is the types of credit lines you have applied for different types of loans.
The new financing will also improve your credit utilization, especially in the beginning when you draw a small loan amount and keep the remaining credit unutilized.
Also, when you keep making payments on time for the newly obtained credit, it will improve your credit payment history. That again will improve your credit score in the long run.
In short, when you carefully utilize new financing, it is a great tool to improve your credit score in the long term.
When Does it Decrease Your Credit Score?
All of the factors mentioned above can adversely affect your credit score as well.
First, the hard inquiries will have a small impact on your credit score. If you apply for several loans in a wide span, your credit score can decrease exceptionally.
Second, a new credit means increasing the number of credit accounts on your credit history. It will decrease your debt-to-income ratio and eventually your credit score.
Third, if you default on payments on your new financing, it will remain on your credit history for as long as seven years. Again, decreasing your credit score for a long time.
Finally, the new financing will decrease your credit utilization ratio. It is natural to think that you’d apply for a new loan when you need to fully utilize it.
In short, new financing can have an impact on your credit score both ways. If you carefully utilize new credit, it can help you boost your credit score. Else, it will decrease your credit score most of the time.
How Do Hard Inquiries Affect Your Credit Score?
A common mistake borrowers make is to apply for several loans over a long span. Most lenders will put a hard inquiry into your credit score and credit history.
A hard inquiry can affect your credit score by 5-10 credit points. It does not change your credit profile drastically if you have only one hard inquiry.
Most credit bureaus consider multiple credit inquiries a single one for the same types of loans made within 15-45 days.
Therefore, whenever you consider comparing different loan options, apply for these loans officially within 15-45 days.
Most loan prequalification applications do not incur hard inquiries as lenders only pose a soft inquiry at that stage.
What Affects Your Credit Score?
Five major contributors affect your credit score. All of these factors change when you apply for new financing.
Let’s briefly discuss these factors.
Your payment history accounts for 35% of your total credit score. It is the highest weightage in your credit score for all five factors.
Lenders are particularly keen to know how you repay your previous loans if any. Therefore, keeping a clean payment history is very important for your credit score.
Loan default is a big red flag for lenders. Even your late monthly payments affect your payment history. These red flags can remain on your credit history for up to seven years.
Your credit utilization is the second most important factor as it accounts for 30% of your credit score.
Credit utilization is the ratio of your total available credit to your withdrawn credit. Simply put, it shows how much of your available loan you have consumed.
Utilizing all of your available credit sends a negative signal to lenders when applying for new credit. It shows you’re likely to apply for a loan again as you cannot repay your previous loans.
Credit History Length
Credit history length is also an important factor as it accounts for 15% of your total credit score.
That is the reason a young credit history will fail to impress lenders when applying for new financing. Lenders want to observe your abilities to repay loans from your credit history.
Therefore, establishing a good credit history is important. The length of the credit history plays an important role in building your credit history.
Credit mix carries a 10% weightage in your total credit score.
The credit mix shows how diversified your credit portfolio is. It comprises different types of loans that you have applied for previously.
It is important to consider that two or more loans of the same type of credit do not increase your credit mix. For example, a credit card and a home line of equity are both considered the same as they are both lines of credit loans.
New credit also carries a 10% weightage in your credit score.
It means as you open more credit accounts, it will decrease your credit score. New accounts also incur new hard inquiries that decrease your credit points.
Also, having too many credit accounts increase your risk of default. Therefore, lenders consider new accounts a risk factor.
Does Refinancing Affect Your Credit Score Too?
Refinancing can affect your credit score in several ways as well.
When you refinance by bundling different types of small loans into one, it changes your credit mix, credit utilization, and new credit factors.
If you can consolidate different loans into one and keep a clean payment history, it can help you improve your credit score in the long term.
Contrarily, when refinancing increases hard inquiries and new credit accounts, it adversely affects your credit score.
Also, refinancing may not help you improve your credit utilization or credit mix. Thereby, decreasing your credit score immediately.
It’s important to note that closing a credit account with late payments does not immediately improve your credit score. Therefore, refinancing for such loans would not increase your credit score immediately.
New financing can increase or decrease your credit score depending on how you utilize it. Five major factors affect your credit score and all of these factors change with new financing.
Therefore, plan for the long term when you apply for a new loan or a credit card to avoid any negative impacts on your credit score.