Credit Scores: Does Applying For Credit Cards Ruin Your Credit Score?

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Credit Scores:  Does Applying For Credit Cards Ruin Your Credit Score?

Million Mile SecretsCredit Scores:  Does Applying For Credit Cards Ruin Your Credit Score?Million Mile Secrets Team

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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
Churning Credit Score
Fico Score Calculation (Image from MyFico.com)

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.

Bottom Line

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.

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Given that Amex dates all personal cards from the time the first Amex personal account was opened, is it true that opening a new Amex card if you already have one impacts your credit score less than opening other credit cards? Length of credit history shouldn’t decrease because average age of all cards wouldn’t decrease.

If I recall correctly, AMEX stopped doing that a few years ago. But back when they were doing that, you’re right. Generally it would not negatively affect your score as much because the average age of accounts calculation would make it seem like the card was opened many years ago.

Can you explain how staying away from credit cards can help fix a lower score? Aside from the short term impact of the hard pulls, how could having new cc’s negatively affect my score?

I just checked creditkarma and my credit score went down 42 points to 739. I don’t think there were any transunion pulls in the past couple years. I did add 2 chase cc (pulled from equifax), and my credit history went down from 45 months to 43 months. Still 42 points seems drastic. Any thoughts?

Also, do you know how AU effects credit age? I’m thinking it would be an idea to become an AU on my fathers old cc. I saw once on my equifax credit report a card (chase BP) opened in 1994 when I was 11. I realized that they were counting the original account opening, though I only became an AU some 10 years later. The implication was that they were counting the original date for credit age, though I don’t know for certain.

I used the 2 browser trick for Citi HHonors Visa (free version) last October, and after getting bonus points and hitting spend, I basically stopped using both of them. Earlier this month, I cancelled 1 of them because there was no activity for about 4 months. I had very little history on this card. My sister said I made a mistake by cancelling it and said that I should keep all free (no annual fee) cards in the drawer. What are your thoughts on this?

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Million Mile Secrets

@Jesson – I’d pay off the card as soon as possible to minimize the impact of a high utilization ratio.

@Dave – It doesn’t hurt to keep an annual fee card forever, but cancelling one card could make sense if you plan on applying for more Citi cards later on. But I would keep a few fee-free cards for a long time to help your credit report age.

Hi, Daraius

I just applied the SPG card and felt really happy that it was approved. However, the sad and very surprising thing is AMEX only gave me 1000$ CL, which is the lowest one that I have ever got since my first credit card. As I need to spend 5K in 6 months. If I spend 900 $ , pay off it, spend 500 $ and pay off all the debt every month to keep 0 balance. Will this activity on my account affect my credit score?

Thank you very much!

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