Credit can be one of the best financial tools at your disposal, if used right. One important thingto learn is when it's a good idea to open a new account, and when it could do more harm than good.
We asked three of our analysts to share some of their best reasons for opening a new credit account, and here is what they had to say.
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Leo Sun: It makes the most sense to apply for a new credit card when you don't have one in your wallet. Sticking with debit cards helps people live within their means, but debit cards don't improve credit scores.
A person's credit limit, on-time credit card payments, and credit history impact his or her credit score, which determines whether car or housing loans can be secured. To establish a good credit score, a person should get a credit card early, keep that line open for as long as possible, and strive to keep its balance near zero.
Credit scores vary by lender and scoring model. For example, Credit.com's credit card comparison tool ranks a score above 750 as "excellent," a score between 700 and 749 as "good," and a score between 650 and 699 as "fair." If we experience another credit crunch and financial meltdown, it could be nearly impossible for someone without any pre-existing credit to finance big-ticket purchases or get a new credit card.
If you have no credit at all, you should sign up for at least one credit card to build a positive credit score as soon as possible. But, by all means, avoid amassing debt across multiple cards.
Matt Frankel: It makes sense to open a new credit account to finance a big purchase without paying any interest, if you understand what you're getting into.
This type of deal comes in two varieties. First, many retailers offer 0% APR financing for a certain period of time (say, 12 months), so if you pay off the entire balance before the introductory period ends, you'll never pay a dime of interest.
However, if you don't pay the entire balance within the given time period, you'll get hit with a bill for the interest from day one of your purchase, even if the outstanding balance is very small. In other words, only go for this type of arrangement if you are 100% certain you can pay off the balance before the promotional period expires.
The second type of 0% APR deal involves certain credit cards, which also offer a promotional period, sometimes as long as 18 months. Unlike the "no interest" financing offered by retailers, you don't have to pay the entire balance back in the introductory period. Interest will simply start accumulating on your remaining balance after the period expires.
This option is definitely the best choice if you have any doubts about your ability to repay the balance quickly. Still, if you need to buy something big, but don't want to pay for it all at once, no-interest financing can be a very good reason to open a new credit account.
Dan Caplinger: It always makes sense to pay as little in interest as possible on the amounts you have borrowed. If you have the financial discipline to control your spending, opening a home equity line of credit can dramatically reduce your borrowing costs and also potentially provide some additional tax breaks.
Home equity lines of credit, or HELOCs, typically carry variable rates that are tied to the prime rate; with interest rates at rock-bottom levels right now, HELOCs have very low finance charges compared to credit cards and most other types of consumer debt. Moreover, many taxpayers can deduct the interest on up to $100,000 in borrowings on a HELOC, further reducing the effective financing costs. For instance, with some HELOCs available at 3% right now, refinancing $25,000 in credit card debt at 13% could save you $2,500 a year in interest and might let you claim the remaining $750 as an itemized deduction.
HELOCs carry two trade-offs, though. First, you put your home at risk if you can't repay the loan. Also, some people use HELOCs to pay off credit cards but then go back and run up new credit card balances, which is far worse than never opening a HELOC in the first place. But if you can avoid those issues, opening a HELOC can be a smart move that can save you a lot of money.
The article 3 Instances Where it Makes Sense to Open a Credit Account originally appeared on Fool.com.
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