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- The 5 dangers of applying for credit cards
- Does Applying For Credit Cards Ruin Your Credit Score?
- Does Cancelling a Credit Card Hurt Your Credit Score?
- Why Everyone Should Have a No-Annual Fee Credit Card
- Why Some Business Cards Impact Your Credit Score Less Than Personal Cards
- Does Getting Denied for a Credit Card Impact my Score?
One of the easiest ways to earn lots of miles and points is by applying for credit cards. And with sign-up bonuses of 50,000 miles and points or more, per credit card, it is fairly easy to earn hundreds of thousands of miles and points in a year.
But folks are – quite rightly – concerned about the impact to their credit score.
The short answer is that in the short-term, your score could decrease, but in the long term your credit score could increase if you pay back your debt on time.
Why You Shouldn’t Sign-Up For Credit Cards
Interest rates on miles and points credit cards are very high, and you should NOT apply for miles and points credit cards unless you can pay off your balance in FULL each month. You will never get ahead in life if you continuously pay 25% or more in interest on consumer debt.
You should also not apply for credit cards if you have trouble budgeting or find it hard to resist the temptation of charging unnecessary purchases to your credit card.
I also wouldn’t apply for miles and points credit cards with a score lower than 700. It is much better to fix a lower score (by staying away from credit cards if need be) and apply for credit cards once your score is above 700.
Lastly, I personally wouldn’t apply for lots of credit cards in the 2 years leading up to a house loan since I want to do everything possible to get approved for a house loan at the lowest possible interest rate. 1 or 2 cards may be okay, but not 10 or 20.
What is a Credit Score?
In the US, a credit score is usually a three digit number which is used to predict the likelihood of you not paying back loans. Fair Issac Corporation dominates the US credit score business and issues FICO scores which range from 300 to 850.
There are 3 main credit bureaus in the US – Equifax, TransUnion & Experian – and you usually have 1 credit score from each bureau.
Is a Higher Credit Score Better?
Yes, but only up to a limit! A score of 650 is better than a score of 550, and a score of 750 will get you access to lower interest rates than a score of 650.
But after a score of ~760, you don’t necessarily get a lower interest rate for having a higher credit score. So there is no real need, besides bragging rights, for having a higher credit score.
For example, if a retired person with a credit score of 830 applies for credit cards and finds her score has dropped to 790, she is no worse off because her credit score still gets access to the lowest interest interest rates. Ramit Sethi of I Will Teach You to be Rich has a similar chart in his post on the importance of a good credit score.
How Is Your Credit Score Calculated?
According to the FICO website, your credit score is determined by:
- 35% Payment History
- 30% Amounts Owed
- 15% Length of Credit History
- 10% New Credit
- 10% Types of Credit
The most important variable is your Payment History or whether you pay your debts back on time. Since this is your credit score it makes sense to attach more importance to your history of paying back your debt!
The next most important variable are the Amounts Owed. Having debt doesn’t, by itself, mean that you are a high-risk borrower. However, if a high percentage of your available credit has been used (also known as having a high credit utilization), it may suggest that you are taking on more debt than is good for you and that you could not pay back your loans.
This is why it is very important to NOT max out our credit cards and to try to have a low utilization rate. For example, if your credit limit is $10,000 don’t charge more than $1,000 to that card if you want a utilization rate of 10% or lower.
Impact of Applying for Credit CArds
If you apply for personal credit cards, the main decrease to your score is from the New Credit & Length of Credit History which account for 10% & 15% of your credit score. But your score could improve because of the extra credit available to you (if you don’t max it out) which accounts for 30% of your credit score.
New Credit (10%) – Decrease. However, each time you apply for a credit card, the banks look at your credit report (sometimes from more than 1 credit bureau). This is called a “hard inquiry” and stays on your credit report for 2 years. According to MyFico, in addition to impacting your credit score, lots of hard inquiries also suggest that you are a riskier borrower to banks.
But no one knows for sure the exact impact of credit inquires on your credit score, since the algorithm which calculates credit scores is a secret. But folks speculate that an 18 month old inquiry has less impact to your credit score than an inquiry only 1 month old. And it is for this reason that some folks like to apply for cards in 91 day intervals since they feel that the impact of recent credit inquiries is less after a 91 day period.
MyFico also lists as fallacy that “My score will drop if I apply for new credit.”
Length of Credit History (15%) – Decrease. Applying for a personal credit card will decrease the average age of your credit accounts, which will decrease your score. But this has only a 15% impact to your credit score. Note that business credit cards from certain banks do not sit on your personal credit report (unless you default) so applying for a business credit card doesn’t impact the Length of Credit History.
Amounts Owed (30%) – Increase. In the long term, applying for credit cards could increase your credit score because you get more available credit which decreases the credit utilization ratio. In other words, you are using even less of the total credit available to you (assuming your spending patterns remain about the same), so your credit score improves. This is why some folks see an increase in their credit score a few months after applying for new cards.
Applying for credit cards is an easy way to earn lots of miles and points to have Big Travel with Small Money. But you should use credit responsibly and not pay high rates of interest. Start slow and gauge the impact to your credit for yourself before applying for more cards.
And here’s a post on the impact of cancelling credit cards.