When a Small Credit Hit is For the Greater Good
Let’s face it: no one wants to purposely hurt their credit. In fact, most personal finance blogs (ahem) typically give you article after article about how to protect and improve your credit score. However, the truth is that there are times when an action that may ding your credit score is a necessary evil and is worth doing in the greater scheme of your finances.
Entrepreneur recently took a look at “8 Times When It’s OK to Ding Your Credit Score.” The article looks at some misconceptions and catch-22s that exist in the FICO credit score system. For example, they note that if you are not making payments on anything (meaning your debts are all paid up), it can actually cause your credit score to fall over time. To combat this they recommend opening and using a credit card while paying off the balance each month. Although applying for a new card will cause a minor drop in your credit for up to a year, it’s better than letting your credit score decay without those consistent payments.
Most of the “credit dings” that the Entrepreneur piece discusses are from what’s known as “hard inquiries.” These inquiries take place when you apply for a new type of credit and they usually take about five points off of your score. However, the good news is that once those lines of credit you’re applying for are approved, your ratio of available credit will likely make up for the penalty rather quickly. In fact the author shares an anecdote about how applying for 17 credit cards in a single day (!) dragged his credit down from a 722 to a 684. However, once he was approved for those cards, his score not only recovered but continued to climb.
Aside from these technicalities that exist in the credit score system, there are some very good reasons to sacrifice the minor penalty of a hard inquiry in the interest of saving money in the long run. For example, while applying for loans your credit report will be pulled each time, resulting in a hard inquiry. But keep in mind shopping around and getting the best rate on your loan is far more beneficial than going with your first offer just to avoid the small credit score hit. The same goes for refinancing a current loan.
Credit scores can be a bit confusing at times but there is a method to the madness. Because of the way FICO calculates and weighs the different parts of your credit, sometimes what’s right for your finances may be temporarily harmful to your score. While it is usually in your best interest to do things that will keep your score up, there are times where taking a little ding is the right call.