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  Everything you need to know about credit scores

Disclaimer: Before we get started with today's lesson, it's important that you know I'm not a financial advisor. My knowledge regarding credit scores and credit cards has come from personal experience over the last four years and lots of time spent researching the internet. Ultimately, what you choose to do with the information below is up to you.

Today's lesson is going to be text based because I think it will be easier to understand if you can go back and re-read any of the material you find confusing.

Your concern regarding your credit score after applying for multiple credit cards is completely valid. That's why I want to dedicate today's entire lesson to explaining how travel hacking affects your credit score. First we need to understand what a credit score is, why it's important, and what factors determine your credit score.

I assume that most of you already have a basic understanding of credit scores, but you'll need to understand some of the more intricate details that you might not be familiar with in order to understand exactly how applying for multiple cards will impact your credit score.

What is a credit score?

Your credit score is a three digit number that lenders use to determine your financial trustworthiness. From a lenders point of view, the higher your credit score, the less risky it will be to lend you money/approve you for a new credit card. There are multiple credit reporting agencies. Most of these agencies issue a score that ranges between 300 on the low end and 850 on the high end.

Your credit score usually needs to be above 700 in order to be approved for the travel credit cards that offer lucrative sign up bonuses. That's not to say that you'll for sure be approved if your credit score is above 700, but there's a good chance you won't be approved if your credit score is any lower.

Who Keeps Track of Your Credit Score?

There are three major credit reporting agencies that you need to be familiar with. When applying for a credit card, the bank will "pull" your credit report from one or more of the three credit reporting agencies listed below.

  • Equifax
  • Experian
  • Transunion

Your score may vary slightly from agency to agency, but overall your scores should be very similar. If there is a big difference in your score between agencies, one of the agencies is probably reporting incorrect information.

In one of the sections below, I'll show you how you can check your credit score for free with each of the credit reporting agencies listed above.

What Factors Make Up Your Credit Score?

Below is a chart that shows the different components that make up your credit score.

Payment History - This section is pretty self explanatory. Have you made your payments on time? The fastest way to damage your credit is to miss a payment!

Credit Usage - This portion of credit score is determined by your debit to limit ratio, otherwise defined as the available credit that you're using. For example, if you have five credit cards and your credit limit is $10,000 on each credit card, your total amount of available credit would be $50,000.

If you've racked up $5,000 worth of charges across your different credit cards, your debit to limit ratio would be 10% [$5,000 / $50,000 = 10%]. The lower your debit to limit ratio the better. According to Credit Sesame you should keep it below 10% to keep your credit score in good standing.

Length of Credit History - This section should be renamed "average length of credit history". All of your open lines of credit are averaged together to make up your average length of credit history. The longer your average length of credit history, the better. This is why you shouldn't cancel old credit cards even if you aren't using them anymore (as long as you're not paying an annual fee).

Account Mix - It's good to have a mix of different types of credit on your credit report. Credit reporting agencies like to see that you can responsibly manage multiple different types of credit. For example, if you have a home mortgage, an auto loan, and a few credit cards that you've paid off on time, this is proof that you're capable of managing multiple different types of credit.

Credit Inquires - This is the section of your credit score that gets damaged if you're applying for new lines of credit (credit cards). Every time you apply for a new line of credit, the bank will check your credit score (a hard credit inquiry). If there are multiple recent hard credit inquiries on your credit report, this signifies to banks and credit reporting agencies that you're in need of more credit (not a good look). This section of your credit score will be best when you have less hard credit inquires.

Hard Inquires vs Soft Inquires (Hard Pull vs. Soft Pull) - You may hear this referred to either way. Many people have the misconception that checking your credit score will damage your credit score. This isn't true. When you personally check your credit score, it's considered a soft credit inquiry. A soft inquiry doesn't get reported on your credit report, and it doesn't damage your credit score. However, when a bank or potential lender checks your credit score, this is considered a hard credit inquiry. Hard inquiries can have damaging effects on credit score, but it's usually very minimal.

How Are These Factors Effected When You Apply for Multiple Credit Cards?

Now we're getting to the good stuff! Let's look at how travel hacking (i.e. applying for multiple credit cards) affects your credit score.

Payment History - Opening multiple credit cards can actually benefit this section of your credit score. Each credit card is considered a separate line of credit. If you're responsibly managing multiple lines of credit (i.e. paying multiple credit cards off on time), banks view this as more proof that you can responsibly manage credit.

Credit Usage - This is another section of your credit score that can benefit from applying for multiple credit cards. Opening a new credit card increases your over all amount of available credit. If you increase your overall amount of available credit without increasing your debt, your debt to limit ratio will drop.

Example: You have $50,000 worth of available credit. Your new credit card gives you a credit line of $10,000. Your debt stays the same at $5,000.

Old Credit Utilization [$5,000 / $50,000 = 10%]
New Credit Utilization [$5,000 / $60,000 = 8.33%]

The lower the better!

Length of Credit History - This section will be hurt by applying for new credit cards. If you're consistently getting new credit cards, your average length of credit history will be younger. Older is better in the eyes of the credit reporting agencies. However, this section only makes up 15% of your overall credit score. It's not a huge deal to decrease your average length of credit history.

Account Mix - Unless you've never had a credit card, this section shouldn't be affected by applying for new credit cards. If you've never had a credit card, it would actually be a good thing to add one to your credit report.

Credit Inquires - This is another section of your credit score that will be damaged by applying for multiple new credit cards, but again it only makes up 10% of your credit score, so it's not a huge deal.

Every time you apply for a new credit card, the credit card company will check your credit score, which means that a hard credit inquiry will show up on your credit report. Hard credit inquires normally only damage your credit score a few points. After a few months, they won't be considered "recent," and your credit score will bounce back to where it was.

Summary of How Travel Hacking Affects Your Credit Score

As you can see from the examples above, applying for multiple credit cards can benefit some sections of your credit score and damage other sections. The good news is that the sections that benefit are weighed heavier than the sections that get damaged.

Once you apply for a new credit card, the bank will check your credit score. This will result in a hard credit inquiry on your credit report that will slightly damage your score for a few months. If you are approved for the card, your new line of credit will decrease your average length of credit history which will also slightly hurt your credit score.

So that's the bad news. The good news is that (if used responsibly) the new credit card will help to increase your credit score because banks view it as more proof that we can responsibly manage credit. Additionally, the new line of credit will decrease our debt to limit ratio, which can also increase your credit score.

I think it's important that you understand the "WHY" behind the effects travel hacking has on your credit score. However, all you really need to know is that applying for new credit cards may immediately lower your credit score a few points, but after a few months your credit score should rebound back around where it started and maybe even increase in the long run. Personally, since I started travel hacking, my credit score has increase from around ~750 to ~770. Below is a screen shot of my TransUnion score from my Credit Karma account.

How to Check Your Credit Score for Free.

As I mentioned before, there are three credit reporting agencies that you should monitor. Below are free ways to get your credit score from each agency. Also, the U.S. government requires these agencies to give you your full credit report for free once per year. You can get your full credit report for free (once a year) at annualcreditreport.com

TransUnion - Check Your TransUnion credit score for free by setting up an account on CreditSesame.com

Equifax - Check Your Equixfax (and TransUnion) credit score for free by setting up an account on CreditKarma.com

Experian - Check Your Experian credit score for free be setting up an account on Credit.com

Homework

Monitoring your credit with all three of the services listed above is probably a little excessive, but you should be monitoring your credit score with at least one of them! I'd recommend going with Credit Karma because you can see your Equixfax and TransUnion credit score.

So your homework for today is to create an account on CreditKarma.com so you can monitor your credit score as you start to apply for travel credit cards.

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