Does a department store credit card really hurt your credit score?

January 27, 2012 in Finance

I came across an article on whether or not closing credit card accounts lowers your credit score, which included this bizarre observation:

The addition of new credit card debt also increases your credit utilization, or debt-to-credit limit ratio, on revolving accounts such as credit cards. For FICO scores, this ratio is part of a factor worth 30 percent of your score.

You've paid off your store card debt, which should help to lower your utilization. According to Barry Paperno, consumer affairs manager for FICO, "in addition to making payments on time each month, the No. 1 concern for people with several new store cards should be ensuring that the amounts owed on these cards are as low as possible."

He says the best-case scenario is for store cardholders to pay off their balances quickly to reduce their utilization, which is figured for each card and across all of their cards.

Now, if this were really true -- that is to say, that the marginal utilization of each new card constitutes such a major piece of your credit score that a department store account could hurt you -- then, conversely, you must be able to raise your credit score by opening as many cards as possible and not charging anything to them! These new cards would have utilization scores of zero, presumably moving your credit score as far up as the department store cards drag it down. I think we all know that isn't the case -- though it may have more to do with other variables besides utilization than some nonlinear utilization relationship.

The article isn't completely wrong, however, because the department store cards it refers to 1) typically have an immediate balance and 2) have low credit limits, resulting in high instantaneous utilization. The smart credit card arbitrageur will pay it off the next day in full, capturing the discount and (if you believe it exists) the low-utilization credit bonus.

The most important thing to remember is that missing a payment wrecks your score. Anything else that could potentially lower it, like opening 100 department store cards, has a negligible impact by comparison. Do not go into default and your score will be fine.

This post is not meant to be financial advice. It is, however, common sense.

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