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3 Major Ways Travel Rewards Affect Your Credit Score
A credit score is determined by several factors, and while the exact algorithm is not known, we can easily see which factors are likely to be affected by travel rewards cards. Here are the three major ways travel rewards affect your score.
1. Amount of New Credit
Signing up for a credit card typically requires the issuer to pull your credit, which is known as an "inquiry." Inquiries are part of the Amount of New Credit category, weighted as 10% of your score.
In my experience, each credit card application costs around 10 points on average (but this number could be as low as 2 points or as high as 20, based on various anecdotal data points). The drop in your score is temporary - evidence suggests the loss will be recouped in 3-6 months. Both personal and business credit cards carry this effect.
Depending on how many cards you are interested in getting, those points may begin to add up.
What Can I Do?
I recommend signing up for credit monitoring services such as Credit Karma, Credit Sesame, or Mint in order to monitor your Transunion and Equifax scores. You can sign up directly with Experian for the third bureau.
If you want to see your actual FICO score instead of the Vantage score, you can sign up for FICO-specific monitoring over at myFICO (created by the Fair Issac Corporation - they are the FI in FICO, so you can't get much closer to the source than that). The service is not free as with Credit Karma, Credit Sesame, or Mint, but this is the surest way to fully understand your score.
Space out applications for new credit by 2-3 months, which helps reduce the number of new inquiries to your account. As some age and drop off, others are added anew.
If you are in danger of your FICO score dropping below 740, do not apply for new cards right away. Instead, look for ways to increase your score to a safer level first.
2. Amount of Debt
The second way new cards affect your credit score is in the Amount of Debt category, worth 30% of your total score.
Adding a credit card increases the amount of available credit on your report. This will likely help your score since it means a drop in utilization, or the amount of available credit you are using.
For example, let's imagine you owe $5,000 on credit cards that carry a combined available credit of $14,000. Your utilization in this case is 36%, a rate that is viewed unfavorably by credit bureaus.
Adding a new credit card that increases your available credit by $10,000 reduces your utilization to 21%.
Note that only personal credit cards matter here, since business credit cards are almost never added to a personal credit report (although there are a few exceptions - do your research before applying).
What Can I Do?
Do not carry a balance on your card. Signing up for credit cards for travel rewards assumes that you pay off your balance in full each month. High utilization can stop that game very fast.
Paying off your balances in full means you have $0 debt (which is always 0% utilization, regardless of your credit limit).
Try to avoid lowering credit limits, especially if you carry a balance. There are reasons why you may want or need to lower limits, such as credit issue limits from companies such as Chase, but be aware of the affect it may have on your utilization.
3. Length of Credit History
Finally, we must consider Length of Credit History, worth 15% of your total score. Your average age of accounts (AAOA) will be affected once approved for a new personal card.
As an example, let's imagine you have three cards: the ages of these cards are 11 years, 4 years, and 2 years. Your average age of account should be approximately 5 years and 6 months.
Adding a new card drops this average age to 4 years and 3 months, which is likely to lower your credit score slightly.
What Can I Do?
Try not to close especially old accounts, which may have a strong effect of aging your new applications.
Closing a card stops the aging process, but the card remains on your report for two years. For this reason, it is advantageous to your score to instead downgrade a card to a no-annual fee version rather than closing the account altogether.
If you do not want to carry the card, you can simply place it in a safe, sock-drawer, or other secure place in your home.
Of course, if you are concerned with the potential for fraudulent charges, if you are looking to simplify your financial situation, or if the card may tempt you to spend when you should not, it may be more worthwhile to you to close the card even with a drop in score.
Good finances are more important than a temporary loss in score. With good practices, you will recover anyway.
Overall, applying for a credit card will result in a drop in your score in the short-term, due to the inquiry to your report.
Long-term, however, the inquiry will no longer count against you. The other two factors, utilization % and AAOA, will remain.
Since utilization affects your score to a greater extent, the net effect should be positive. As further anecdotal evidence, I have seen my credit score rise around 25 points since beginning churning in 2016. There are more fluctuations than before I began, but the average is indeed higher.
There is one additional caveat that should not be ignored. If you are planning to apply for a car loan or mortgage in the next six months, stop credit-card signups until you are finished.
Lenders may look at some sections such as number of inquiries in addition to the actual credit score (this is akin to you being penalized twice). Refraining from churning for a time will give your score a chance to improve, outweighing other concerns from the lender.
Credit scores can be frustrating because the full causes-and-effects are not known. Understanding these 3 major ways travel rewards affect your credit score will help though.
If you are interested in learning more about travel rewards, don't forget to check out my page on Travel Cards! Don't be afraid to ask if you have specific questions.
What effects have you seen in your credit score from churning activities? Do you follow any particular rules of thumb when applying for new credit? Have I missed anything in my analysis? Comment below and let me know!