How a New Credit Card Can Improve Your Credit Score -- if You're Careful

There are plenty of great reasons to open a new credit card account. Many cards come with sign-up bonuses, for example which means that you can get points, miles, or cash back for spending a certain amount on the card within a certain period of time. A new rewards card could also be a better match to your spending, or your new card may come with perks like airline lounge access that you didn't have before.

There's another really important reason you may want to sign up for a new card: Doing so could improve your credit score -- but only if you are smart about how you use it.

There's a simple reasons your new card could help improve your credit score

A new card may have a major positive impact on your credit score because that new card comes with a new line of credit.

Many factors go into determining your credit score, and one of them is your credit utilization ratio. Credit utilization ratio refers to how much of the credit available to you you're actually using. It accounts for a whopping 30% of your FICO® Score, second only to payment history (which makes up 35%).

Opening a new card gives you more available credit, which, in turn, can help improve your credit score -- if you know how the rules work.

Understanding credit utilization

The credit utilization component of your credit score is pretty easy to understand. Here's an example:

• Say you have a credit card with $1,000 in available credit.
• If you charge $500 on the card, you'd divide $500 (credit used) by $1,000 (credit available).
• In this scenario, you'd have a 50% credit utilization ratio

The lower your credit utilization ratio, the better your credit score is likely to be. That's because not maxing out your cards shows you can be responsible with credit. And having a low balance means you're much more likely to be able to make payments on the debt you do owe, since you won't be overwhelmed with obligations.

It's best not to let your credit utilization ratio get above 30%, but since you're better off with keeping this ratio as low as possible, adding a new card to your arsenal is really helpful because of the new credit line that comes with it.

Let's take our above example and assume you added another new card -- this time with a $2,000 credit limit. Now, you have:

• A credit card with a $500 balance and a $1,000 limit
• A credit card with a $0 balance and a $2,000 limit
• Your new credit utilization ratio is $500 (credit used) divided by $3,000 (total credit available). That gives you a utilization ratio of about 17%.

As you can see, you have a much more favorable utilization number now, so your credit score should improve.

Here's why you need to be careful

You do need to be careful with your new card, though. Specifically, you don't want to charge too much on it. If you do, then you could hurt your utilization ratio by increasing your credit used. If you get in over your head and start missing payments, that could lead to even bigger problems.

So, when you apply for a new card, be sure to use it wisely. Charge only a limited amount and pay off your balance in full each month. That way, both the new line of credit and the positive payment history it provides can help you improve your credit score over time.