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The Big Question
“Would You Like to Save 15 percent with today’s purchase? It will only take 60 seconds.”
Holiday shopping is now in season. Have you heard this phrase yet? More importantly, do you realize how these small store credit cards impact your credit score?
As a mortgage professional, I think about this all of the time. But let me share the dirty truth about this tricky little promotion. That 15 percent off of today’s purchase could cost you thousands of dollars in the future, and we’re not just talking about the 18 percent annual percentage rate they charge you. That’s just icing on the cake.
Your Credit Score
Your credit score is made up of five parts:
The decision to open up a store card impacts two of these categories directly, and will affect the other three in the future.
Immediate Impact
As soon as you open a store credit card, you are changing the “new credit” and “length of credit history.” That’s 25 percent of your credit score that you’re impacting with your 15 percent savings on TODAY’S PURCHASE. Effectively, you’re bringing down the average age of your accounts and looking like you’re hard up for credit - especially if you are applying for numerous credit card offers.
Do the math: Save 15 percent on today’s purchase for a 25 percent impact on your credit score. I wish I could tell you the exact impact your actual credit score, but since credit scoring is a ninja art, I cannot. What I can tell you is that it will likely impact you more than 20 points. That’s a lot.
When Your Bad Decision REALLY Hits Your Pocketbook
Let’s say you sign up for that credit card in the store to save the whopping 15 percent. Two months later, you decide you want to take advantage of this killer $7,500 tax credit that is available for first-time home buyers. Since your credit score fell, your interest rate on the mortgage is slightly higher (let’s say .25 percent). The $200,000 loan you’re getting now costs you $32 more each month. That might not seem like much until you figure out that is $11,520 over 30 years. Chump change, right?
Next time someone offers you a store credit card with some sweet discounts, think about it. It’s not as sweet as you think. No matter how much you want that big Christmas sweater for your party.
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Comments
12.22.08
This is very interesting. I was always told that as long as you don't carry a balance, having a couple of store cards where you shop most often doesn't hurt your credit that much, or at all.
Say I have 3 store credit cards and a general credit card through my bank. and then I decide that closing one or two is necessary because I just don't use it that often. Does that actually 'correct' the score, or does it stay 'burdened' for a time period.
I have been told that applying to multiple cards is very bad for your score.
...thoughts?
12.22.08
Tyler - awesome post. I've always been curious about credit ratings... I've heard that everytime you close a credit card it brings your balance down because there's a decrease in credit that is available to you... Any truth to that?
Also - When you're shopping around for a mortgage, if you have a bunch of companies run a credit report for you, how does that affect your score?
Thanks for the info!
12.22.08
@Anonymous - Great question. The rule of thumb is to carry 2-3 credit cards at one time. It doesn't matter whether it's a 'store credit card' or a regular AMEX/VISA/Mastercard.
The big issue with applying for store credit cards is you open the card for the discount, then close the account right away. This definitely hurts your credit score.
Your credit definitely takes a hit every time you open up a new credit card. It takes about 6 months to 'get back to normal'.
@Andy Drish - There's tons of truth to closing cards hurting your score. It's good to keep the cards out there, even if you're not regularly using them. I personally encourage people to use a card every 6 months. This simply assures that the card doesn't get canceled by the credit grantor due to lack of use.
When shopping around for home loans, you have 45 days to pull credit with it not impacting your credit score. When buying a vehicle, you have 30 days. Just remember that your credit report is only good for 120 days to a lender. If you wait past that, your credit score may decrease the next time they pull credit, resulting in a higher interest rate or even worse a denial.
12.22.08
How does opening a store card impact your "length of credit history"? That should go back to your first card, not change as you add cards.
12.22.08
@Anna - I'm not sure what you mean by the history going back to your 'first card'.
Your account history is referring to the history of each individual account. Each credit card you have is an account. Therefore, if you open up a new card, you have a brand new account with very limited history.
Thanks for voicing your question!
12.22.08
@Tyler, I can't imagine that it's good for anyone's credit to have accounts years after they've stopped using them. Surely closing an unused account or two periodically isn't all that damaging. Plus keeping all those accounts open seems to offer more opportunity for abuse by others who get hold of your number.
And if someone isn't shopping at a particular store any more, why should they buy something there every six months just to keep an account active, when they wouldn't otherwise use it?
I get what you're saying, and I agree with it--better not to open the account in the first place. But I hear a lot of "don't close a card because it could affect your credit score," and I've closed many cards and have excellent credit.
What often gets left out of these discussions is this: the ratio of available credit to your balance. If you have a high credit limit on a card and don't carry a large balance, closing a store account isn't going to make a gigantic difference in the long term.
12.22.08
@KateNonymous - I see your points Kate.
Here's the thing: There's "Credit Scoring" then there's "Common Sense". Unfortunately, the people behind FICO scoring aren't the most common sense oriented people.
You have to choose if you're going to live your financial life to do what makes sense to you personally or to flaunt the best FICO score possible. I am not deciding that for anyone, I am just trying to help you understand what it would take to do the second option ;)
The whole point of a credit score is to determine a person's likelihood of a 90 day late occurrence. Plain and simple. With no recent activity (or open cards with long histories) they cannot predict the likelihood of this happening as easily.
I hope that helps ;)
12.22.08
The common-sense advice I've heard is this: Keep the card you've had the longest. That way you maintain the longest possible credit history.
That's different advice from "don't close a card."
12.22.08
@KateNonymous - Semantics ;)
12.22.08
Not really. Keeping your oldest card is not the same as using a store card just to keep the account active, or never closing a card.
Common sense also tells me that the more cards a person has, the harder those cards are to keep track of. Since a big part of managing your money involves knowing what accounts you have, fewer cards are easier to track.
Ultimately, as you point out, it's about taking the long view. The immediate discount may have negative repercussions down the line. Using common sense in this way, on the other hand, can pay off down the line.
12.22.08
@Tyler
Unless I'm mistaken, length of credit history means how long it's been since you started using credit--since you opened your first card. Unless I close the card I opened in 2005, opening a new account won't change the fact that I have a 3 year-long credit history.
12.22.08
@KateNonymous - Not sure where you're going with this. I'll just call it good and let readers go to www.myfico.com to clear up any confusion they might have.
@Anna - You would be mistaken ;) When looking at a credit report, you'll often see one of the main contributing factors to a credit score is related to the length of a specific account's history.
I'm feeling like no matter what I say as an expert will be disregarded. If you have concerns on how credit scoring is computed, feel free to check out www.myfico.com. FICO scoring is a black box art as it is.
I don't claim to know it all, but I look at 10 credit reports a day. I've seen a few things :)
12.22.08
@Tyler
No need to be defensive--but your information doesn't jive with the likes of Clark Howard.
Thanks for the information anyway.
12.22.08
Interesting post... and subsequent comments. This is exactly why I don't worry about my credit score and I just pay my mortgage and everything else is paid for with cash. No credit cards for this girl I'm off the grid! (for credit anyway)
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