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One of the best ways to improve your credit scores in the long run may seem counterintuitive at first: Open a new credit card.
Here's how it works. When you open a new credit card, you are increasing the number of tradelines, or accounts, in your credit report. If you have a "thin credit file," that means you don't have many credit accounts listed on your credit reports. (Typically, a thin file has anywhere from one to four accounts.) Generally, a thin file means a bank or other lender is unable to determine a credit score because there is not enough information in a user's credit history to do so.
How a New Credit Card Can Improve Your Credit Scores
By opening another credit card account, you can fatten up your thin file. Another account can show lenders how you handle credit and help you establish a good track record of paying bills on time. (It's important to note that when you first apply for new credit, your credit scores can take a temporary hit; but the drop is just that—temporary.)
A new credit account can also improve your credit file's diversity, also known as credit mix. For example, if you only have an installment loan in your credit file, adding a credit card can improve your scores because it demonstrates to lenders that you can manage different types of credit.
Another credit card can also help you with your credit utilization ratio, an important factor that goes into calculating your credit scores. Credit utilization ratio is basically the amount of credit you're using compared with the amount of credit you have available to you. So if the total credit limit across all your credit cards is $5,000 and you owe $1,000 total on those cards, your credit utilization ratio is 20%. The lower your utilization ratio, the better your credit scores (experts recommend staying under 30%). Adding a credit card can increase the amount of credit you have available to you, thus allowing you to lower your ratio—provided you don't start charging a lot on the new card.
Three Questions to Ask Yourself Before Applying For a New Card
Of course, if you are going to get a new credit card to improve your credit, there are several caveats. The new credit card can actually hurt your credit if you don't use it the right way. For example, if you get the new card but then don't pay your bills on time, that new card is almost certainly going to damage your scores. So ask yourself these questions before applying for a new card:
1. Will I pay the card on time each month?
If the answer is no, then there's no question: Getting a new credit card is not right for you. If you're not good at handling monthly bills or keeping track of when payments are due, another credit card will only hurt you.
2. Will the new card tempt me to spend more?
If having another credit card will tempt you to spend more money than you can afford, then it's not right for you—and will hurt your scores in the process. That's because the more debt you carry, the higher your credit utilization ratio—not to mention the more money you will pay in interest. Adding a credit card to your credit file is only a smart idea if you know you can use it for necessary expenses and pay the bill off every month.
3. Does the new card come with annual fees?
Before you get a new card, you should consider what kinds of fees it assesses. That's not to say you should never get a card that charges an annual fee. Some secured cards, for example, do charge annual fees, but they are a good way to get started in the world of credit. Other cards charge annual fees but offer all sorts of perks and rewards that make the fees worthwhile. Still, you should always weigh whether the fee is worth it—and shop around for cards that may have lower fees, or none at all.