Education of a Points Freak, Q2 – Won’t applying for credit cards hurt my credit?

• Education of a Points Freak – Introduction
• Question 1 – Is accumulating points and miles for everyone?
• Question 2 – Won’t applying for credit cards hurt my credit?
• Question 3 – What are the pros and cons of different airlines’ mileage programs? (US Legacy Airlines)
• Question 4 – What are airline alliances and how are they useful?
• Question 5 – How can I keep track of all my account balances?
• Question 6 – What are other useful tools I can use?
• Question 7 – What are some good credit cards to start with?

When my friend first told me about how he covered the costs of his honeymoon flight through points earned from credit card sign up bonuses, I naturally was skeptical. Shouldn’t that mess up his credit? How is a free flight, even in business or first class, worth that? Turns out I didn’t have a full understanding of how my credit score is calculated. As you can see from the above graphic, my credit score has stayed pretty steady despite all the new credit cards I’ve opened (three in the nine months before that last point in August). In fact, my credit score could probably still be considered excellent. So let’s take a look at how credit score is calculated, and how applying for credit cards affects that – both negatively and positively.

For reference, I got that graphic from Credit Sesame, a site I highly recommend for budding points enthusiasts. It gives you an estimate of your credit score from Experian, one of the three credit bureaus that banks use when you are applying for credit. There are three main factors that affect your credit score when applying for cards, and that is what you need to think about if you hope to become a points freak. Under each factor, I’ve noted positive and negative benefits of applying for a bunch of credit cards, but note: this is all assuming you pay your bill off every month. If you don’t have the means to do that, you should seriously consider not getting involved in the points game, due to the reasons I outlined in my first post in this series.

In case you are unaware, there are three major credit bureaus: Experian, Equifax, and Transunion. Each calculates a “score” that estimates how much of a risk you are for someone to give credit, or a loan, to. The higher the score, the less risky you are considered, which gives you the best rates and the highest credit limits. That’s the basics in a nutshell. On to the effects on your credit when you apply for new credit cards:

1. Number of Credit Inquiries

The number of credit inquiries (or checks) on your report definitely affects your credit report and score. Most people know this, what you might not know is inquiries only stay on your report for two years. After that, it’s like they never happened. Another thing to note is not all banks check credit from the same credit bureaus. Say I apply for a Chase credit card and Chase checks my Experian score. The next day, I go to Barclays and apply for a different credit card. If Barclays uses Transunion to check my credit, they will have no idea that I have a credit check on my Experian report (thus my Transunion score will be a little higher). This is something points freaks like me can use to their advantage.

Another nice tidbit is, if the same bank pulls your credit from the same credit bureau on the same day, it only registers as one credit check. For example, I applied for two Citi credit cards earlier this month, but when I checked my credit report a few days ago, there was only one credit “pull” from Citi on it. This should give you some ideas of how one can ameliorate the negative effect of credit pulls. Still, the number of credit inquiries generally only leads to a negative impact on your credit score.

Negative impacts: Every credit inquiry in the last two years brings your score down, generally proportionally to how recent they are (the more recent, the more they bring it down)

Positive impacts: None, though there are some tricks you can use to your advantage to minimize the negative impacts

2. Average Age of Accounts

The second thing to consider when applying for new credit cards is your average age of accounts, which is literally an average of all the accounts you have. Closed accounts count towards this, but only for a certain number of years (when I was reading my credit report, it was saying that my closed account would stay on for ten years, so my assumption is it won’t factor in after that point, but I could be wrong).

When you open new credit cards, obviously your average age of accounts (AAoA) will decrease, hurting your credit. However, if you keep them open, then your AAoA will gradually increase, improving your credit score. In general, I’d recommend keeping ALL cards that have no annual fee open in perpetuity, because they only will help your credit score. Cards with fees you should close if you don’t think the fees are worth it. If you are opening credit cards, getting the bonus, and then closing most of them within a year, in general, your AAoA should stay pretty constant. This is because its the cards you are keeping (in my case, the non fee cards I had before I started this points madness) that are pulling up your AAoA. Fuzzy math!

Negative impacts: Opening new cards will decrease your average age of accounts and pull down your credit score

Positive impacts: Eventually your average age of accounts will increase and improve your credit score over time

3. Credit Utilization – ratio of debt to credit limits

The biggest positive impact from getting new credit cards is improving your credit utilization ratio – the ratio of the amount of money you put on your credit cards to your total credit card limits. Simply put, banks want to know you’re not borrowing all the money available to you, because if you are, that’s a major red flag. Whenever you are approved for a new credit card, a bank is agreeing to lend more money to you, thus the total amount of money available for you to borrow increases. If you continue to spend the same amount of money on your bank of credit cards, your credit utilization ratio decreases, and this increases your credit score.

Quick example: I have two credit cards with a credit line of $5000 each and put about $1000/month on them. The total credit available to me is the sum of these two credit lines ($10,000), and my credit utilization ratio is $1000 / $10,000, or 10%. If I apply for a third credit card and get approved for a credit line of $10,000, the total credit available to me increases to $20,000. But if I still only spend $1000 a month, then my new credit utilization ratio is $1000 / $20,000 or 5%. Since it’s gone down, my credit score should increase!

Negative impacts: None, as long as you don’t start spending way more money since you have shiny new plastic 

Positive impacts: As long as you keep your spending about the same, your credit utilization ratio will decrease and your credit score will increase!

Final Thoughts

In general, if you are starting with good credit, applying for new credit cards will probably follow this pattern: small drop when applying, followed by a gradual increase in credit score over time after that if you spend the same amount of money and pay off your bills. Even if you don’t have a long credit history, you can slowly build history by applying for two or three cards a year and keeping some of them open. But as I’ve said before, be wary of applying for too much credit if you have a SERIOUS credit need in the near future like a mortgage.

If you are getting into the points game, it’s important to keep tabs on your credit using websites like Credit Sesame or Credit Karma (free!). Note that neither of those gives you your actual credit score, but they are good estimates (I just look for trends – up or down). You should also be checking your actual credit reports once a year using annualcreditreport.com. Also, if you’d like to learn more about how your score is calculated, I’ve found this page very helpful.

My major takeaway from this entire post? Applying for new credit cards regularly does not hurt your credit score as much as you might think – and might even help it.