Here’s how a credit score works!
A credit score using the traditional FICO, or Fair Isaac Corporation, method ranges from 300-850, 300 being the worst score possible and 850 the best possible. Below, I have attached a graph from MyFICO, the company that issues the FICO scores, explaning what exactly makes up your credit score.
Types of credit – 10% of your score – include credit cards, charge cards, store charge cards like a Macy’s car, car notes, mortgages, etc. The more types of credit you have, the better this part of your score will be. For me, since I live in New York, I don’t have a car and can’t (yet) afford an apartment, so I only have credit cards. My score, however, is still excellent. This is tied for the smallest overall percentage of your credit score.
New Credit – 10% of your score – is a measure of how many new accounts of all types you have opened. All those inquiries on your credit report? Each one costs you a particular amount of “points” on your credit score. For reference, credit cards are usually between 2-5 point hits. Since I usually apply for credit cards every 90-91 days, I constantly have new accounts showing up on my credit report, and therefore, hurting this part of my score. However, this category is tied with types of credit for smallest percentage of your overall credit score, so I’m not worried.
Length of credit – 15% of your score – measures how long you have had credit (no, duh, Joe!). Obviously, the longer you have had credit, the higher your credit score will be. This penalizes recent acquirers of credit, as they rightly don’t have a history, but over time, this improves. One way to get around this is to have parents make their children authorized users on their credit cards, which gives them “history,” even though the children might not ever get a chance to use the credit card. Still, since it’s only 15% percent of your score and improves as long as you stay alive, it’s not the most important factor to think about when trying to achieve a higher credit score.
Read this next part more carefully (or, better, most carefully). The two factors below comprise 65% of your credit score!
Payment history – 35% of your score – is another way of asking the question, “Do you pay on time, and if not, how long do you take to repay?” It is absolutely essential to pay on time – a late score, whether 30, 60 or 90 days, or even longer – will stay on your score for up to 7 years, which is a giant red flag when applying for new credit. However, it’s crucial to note that if you are mistakenly late once on a credit card payment, you can often call up the bank and plead ignorance/forgiveness. If you have a history of on-time payments, they will most likely forgive the late payment and will not report it to the credit bureau. This happened to me once when I was younger and dumber. Feel free to also escalate the matter if you don’t think you are getting the response you want.
Second, it is very important to not only pay on-time, but in full every single month. The interest rates on some cards can approach 25-30%, which completely destroys the miles / points earned by spend. For example, paying $300 interest each month for three months means that “free” ticket you booked on points really costs $900. You want to avoid that.
Amounts Owed – 30% of your score – represents how much of your total credit you are using, or “credit utilization.” This part of your score can be drastically changed for the better by applying for more cards, which gives you more credit. For example, pretend you have one card with a $1000 limit and you want to buy a new refrigerator because the old one conked out. However, the fridge costs $800. Obviously, you can buy put it on your one credit card because $800 < $1000. However, to the bank whose credit card you are using, it looks like you are using 80% of your credit limit, which is a big red flag. They assume that you are “maxing out” your available credit and your credit score will dip (scroll down to “Amounts Owed Tips” on the link to the left) because of it.
(However, please ignore the last bit of advice in the “Amounts Owed Tips” portion. If that was true, I wouldn’t be writing this blog, I wouldn’t have traveled around the world in first-class twice and would have only one or two credit cards.)
Now, pretend that you have two or even three credit cards, each with limits of $1000. The fridge still costs the same – $800. However, your credit limit is now $3000, which means your use of available credit is around 27%, which is near the optimum limit of 1/3 of your available credit. For proof, here is a screencap from Motley Fool, an investment site.
Additionally, from Mint.com, I found the below blurb:
To sum up, don’t worry much about this part of your card once you get 2 or 3 cards, or have one card with a large limit – the credit limits will take their of themselves.
Opening, Getting the Bonus On and Closing Credit Cards
By now, hopefully you know your credit score, also have a copy of your credit report and and are comfortable with the idea of credit. So, what now? Keep reading – this next part is all about figuring how to maximize this information for your travel and/or financial benefit!
Opening Credit Cards
When should you know before applying for a card?
- If you are applying for a mortgage, car note, student loan, or any other kind of large loan in the next 6-9 months, do not apply for cards. Having multiple inquiries on your credit report can discourage lenders from thinking you are a safe repayment bet. With a mortgage, for example, the difference over 30 years between a 5% rate and a 7% can be the difference between affording the house and not.
- However, a positive of having a car note or mortgage and paying each on time will increase your credit score. Additionally, having a mortgage, car note or other loan does not disqualify you from applying for new credit cards.
- My advice is if you do not have a credit score above 730 on the FICO scale and a credit history of less than two years, don’t churn credit cards. FICO, as I mentioned before, is an acronym for Fair Isaac Corporation and they basically invented the credit score. Remember, FICO’s scale ranges from 300-850 and is a way for lenders to measure credit risk.
- A higher score is a better score. Experian, one of the three main credit bureaus, suggests anything over 700 is good. (The other two bureaus are Equifax and TransUnion.) MSN Money says that while previously anything over 720 would get you the lowest mortgage, today the requirement is 740 and above. Anything above 740, of course, is gravy.
What if my credit score is “above excellent?”
If your credit score is 800 or above, rejoice! You are extraordinarily wise when it comes to monetary matters and your attitude toward credit will serve you excellently well into the future. However, there is no difference in the mortgage interest rate for someone with a score of 820 versus a score of 780 or even 760. Even having a perfect score of 850 (which I honestly think is impossible unless you have, like, 100 mortgages, car notes and credit accounts with a perfect fifty year history of never being late) will not help you get a better interest rate than someone who has an “above-excellent” score fifty points lower. Basically, if you feel comfortable at 760, but your score is 800, you have forty points to play with when applying for new credit cards.
What if I have a credit score under 700 or no credit?
There is no shame in having a bad or poor credit score – poop and/or life happens. However, banks will probably not accept your application for rewards-earning credit cards. If you have no credit, consider opening a secured credit card, where you deposit a certain amount in a secured account with a bank. The bank offers you a credit limit based on how much is in that account. It’s a great way to build credit if you have none, since you can’t overspend your limit (Remember also that most of the best rewards cards require a score of 720 or higher and a two year credit history)
Why are my scores different?
As you can view above, my Experian score is different from my Equifax score. The score depends on factors like the preference of the bank in choosing a bureau or even the state where you live, as the inquiry when you apply for a credit card will go to certain credit bureau(s) over others. I live in New York and pretty consistently Experian and, to a lesser extent, Equifax are the credit bureaus used. Barclaycard is my only pull on Transunion, which is the 3rd main credit bureau. I do not know what my FICO score is at the moment, because I do not have a membership with them, although I assume it closely parallels the above picture, as otherwise I would not be approved for new cards.
Achieving Signup Bonuses:
So, you were successful in applying for the card and 7-10 days later it’s in your mailbox. Great! Now, your goal is to achieve the signup bonus. Signup bonuses can range from 5,000-100,000 miles/points or some cash equivalent (I usually don’t look at a card unless the bonus is at least 50,000 miles or points).
How do you get the signup bonus?
In some cases, the signup bonus, or at least part of it, is achieved after the first purchase. An example of this is the American Express Starwood credit card, which offers 10,000 SPG points after first purchase and an additional 15-20k points after spending $5,000 in the first six months of card membership. Other cards offer the full signup bonus after you spend a certain amount – let’s say, $3,000 in 4 months. The majority of cards on the market, one example being the Chase Sapphire Preferred, have these offers. Other cards have super-tiered bonuses, where you get the regular bonus after spending a certain amount and then another bonus after spending a much larger amount over a larger amount of time. One card like this is the Citi Hilton Reserve, which offers 2 free weekend nights after spending $2,500 in the first 4 months and then another free weekend night after spending $10,000 over the initial year of card membership.
After you hit the spend, the points are usually posted to your account at the end of the same billing cycle.
Closing Credit Cards
So i’s been close to a year and you’ve applied for the card, been approved, hit the signup bonus and used the points to fund a fun trip somewhere. Fantastic! However, the annual fee could be coming at the end of the first year of card membership and no one wants to pay an annual fee.
What to do about the annual fee?
With some cards, the benefits of keeping the card outweigh the annual fee. Some cards, like the Chase Sapphire Preferred, offer a 7% bonus on points earned in a year. The American Express Platinum, among other ancillary benefits, offers a $200 credit towards the airline of your choice. Some cards, frankly, are good for only the signup bonus and are not worth putting any additional spend on or paying the annual fee.
One point – only think about closing cards that have annual fees. Cards that have no annual fee should be kept forever to age your account history, which makes up part of your credit score.
You can also call up the credit card issuer and ask for an “adjustment,” a.k.a. points or a statement credit, to lessen the financial pain of the annual fee (I do this with all of my cards, even the ones with no annual fee). Factors you could mention in the call could include: the amount of spend on the card, the availability of a better card elsewhere or that you don’t want to pay the annual fee – anything you feel is legitimate, is. It’s your card and your money. Here are two examples – one involving American Express, the other Chase – of me asking for points/cash and getting a pretty sizeable “bribe” to not cancel the card.
Maybe, however, you just want to close the card.
What happens to your credit score after you close a card?
The impact of closing cards can be found in this link, which is an interview with a MyFICO Product Support Manager. Some highlights are below:
1. Even a canceled card stays on your credit report for up to ten years – this helps your average account age.
2. There is no difference on your credit score if you cancel the card or if the issuer does.
3. There is no such thing as “too much credit” in the eyes of the banks. This is a misconception that, in my opinion, a surprisingly number of people have.
4. One tip from me – if you are calling to cancel a card, ask to put the credit from that card on a different card from the same issuer. Not doing so reduces your total amount of credit and, therefore, your credit score. Do not close the card if the customer service representative says no. Hang up and try again!
I’ve cancelled multiple cards from multiple banks and my credit score is still excellent. Don’t be afraid to close a card. Don’t pay these banks any more money than you have or want to.
Thanks for reading – now, head over to my Suite Dreams page to find out if an unforgettable vacation is right for you!