3. The Truth About Rewards Cards and Your Credit Score

Welcome to Point Me to First Class, the only show for employed professionals, entrepreneurs, and business owners who are looking to optimize their higher-than-average expenses to travel the world. I'm your host, Devon Gimbel, and I believe that your expenses are your greatest untapped asset if you know how to leverage them. Ready to dive into the world of credit card points and miles so you can travel more, travel better, and travel often? Let's get started.

Hello everybody, and welcome to this week's episode. Today we are going to talk about the truth about credit cards and your credit score. You may have heard me say on the last episode that one of the biggest mistakes that people make in the points world is having only one points earning credit card, and that it can actually be really advantageous to have several, maybe even many, rewards credit cards in terms of optimizing your ability to earn a lot of points.

Invariably, one of the most common questions I get from people who are learning about rewards cards and points is won't opening up a bunch of new credit cards damage my credit score or make a drop significantly? I can completely understand this concern as someone who cares about their credit score and wants to maintain a strong credit score. So I wanted to walk you through exactly what goes into your credit score and then highlight how applying for new credit cards can impact your score both in the short term as well as in the long term.

So first, I'm gonna break down for you the main contributors to your credit score so that you can understand how applying for and getting points earning credit cards can impact your credit score. Once you understand the factors that influence your credit score, it will be so much easier for you to know how to protect your credit score while continuing to get more rewards credit cards and use them to earn points.

So a credit score is a three digit number, typically between 300 and 850 designed to represent your credit risk or the likelihood that you will pay your bills on time. Now, most people know that a higher credit score is better, but they aren't exactly familiar with the actual factors that contribute to their credit score or how important each one of them is. After today's episode, that isn't going to be you.

So there are five main factors that influence your credit score. These include your payment history, your credit utilization ratio, new credit accounts opened by you, your length of credit history, and your credit mix. Now these factors do not all contribute to your credit score equally. So let's look at each one and how exactly they impact your credit score.

The single most important factor in determining your credit score is your payment history, which accounts for 35% of your overall credit score. This is your history of paying your credit card statements and loans and bills on time. This is why it is so important to never miss a payment on a credit card. Because even one missed payment can negatively impact this aspect of your credit score. In fact, a payment that is more than 30 days past due can cause your credit score to decrease by as much as 100 points. Not only that, but late payments can stay on your credit report for as long as seven and a half years.

The second factor in determining your credit score is one of the most important but the least understood, and that is your credit utilization ratio. This accounts for 30% of your overall credit score. Credit utilization ratio is how much of the overall credit available to you is actually being used at any given time. Now, when you have a lot of available but unused credit, that leads to a lower credit utilization ratio, which has a higher positive impact on your credit score.

So how do you know what your credit utilization ratio is? Say that you have one credit card with a $10,000 limit, and you have a balance of $1,000 on that card. You would be using 10% of the credit available to you. So your credit utilization ratio would be 10%. When your credit utilization ratio is low, around 10% or less, that has a strongly positive impact on your credit score.

The third element of your credit score is your credit history, which accounts for 15% of your credit score and reflects the length of time your credit accounts have been open. Lenders generally look at the age of your oldest account, the age of your newest account, and the average age of all your accounts when factoring your credit score. A longer age of credit is better for your credit score.

The fourth element of your credit score is new credit, which is the number of recent credit inquiries into your credit report. More credit report inquiries can lower your score as lenders can see it as a risk if you're opening up multiple new accounts, especially over a short amount of time. The important thing to know is that this is actually one of the least influential aspects of your credit score as it accounts for only about 10% of your overall credit score.

The fifth and final element of your credit score is your credit mix, which is having a mix of loan types like credit cards, student loans, a mortgage, or car loans. Having a mix of different types of loans is good for your score because it shows lenders that you can manage multiple payments at a time. Credit mix accounts for 10% of your overall credit score.

Knowing these factors and the relative importance in determining your credit score helps you to predict how your credit score can be affected when you apply for new credit cards. So what happens when you apply for new credit cards is that you can absolutely see an initial decrease in your credit score.

That is because opening new credit accounts by itself can decrease your score, and having new credit accounts decreases the average age of your credit accounts. So both your new credit as well as the credit history components of your credit score do go down when you apply for, get approved for new credit cards. But remember that those two factors combined to account for only 25% of your credit score.

When you get approved for a new credit card, one of the most important contributing factors to your credit score can change for the better, and that is your credit utilization ratio. Remember that the credit utilization ratio is just the amount of credit available to you that you actually use at any given time. That having more available or unused credit leads to a lower credit utilization ratio, which has a higher positive impact on your credit score.

For example, if you have $50,000 of credit available to you across all your credit cards, and you actually use about $10,000 of that credit, your credit utilization ratio would be 20%. If on the other hand, you have $100,000 total credit available to you across all your credit cards, but you still only utilize about $10,000 of that credit, your credit utilization ratio is much lower at 10%.

Now your spending is exactly the same. But because you're using a lower percentage of the credit available to you, your credit utilization ratio is lower, which has a positive impact on your credit score. Now if you have $200,000 of credit available to you across all of your credit card accounts, and you still are only using $10,000 of that credit, your credit utilization ratio will be even lower at 5%.

Using less than about 10% of the overall credit available to you has a hugely positive impact on your credit score. When you use very little of the credit that's extended to you lenders see you as being more responsible with your credit.

The important thing to understand about the credit utilization ratio component of your credit score is that it accounts for a higher portion of your credit score than the credit history and the new credit components do combined since it accounts for 30% of your credit score all on its own. I think this is one of the most counterintuitive aspects of our credit score. It seems like you would be seen as more responsible if you only carry one credit card than if you have 10 or 15 credit cards.

But when you understand the concept of credit utilization ratio, you can understand why having more credit cards can actually improve or increase your credit score. Because as you get more new credit card accounts, the overall amount of credit available to you also increases.

Now as long as you continue to utilize the same amount of credit as you usually do and don't just increase your spending, your overall credit utilization will drop, and this component of your credit score will be positively impacted. Over time, the impact of a small credit utilization ratio on your credit score will make your overall credit score increase even as you get approved for more new credit cards.

Now, I can tell you from my own personal experience, my credit score actually did improve over time when I started getting more rewards credit cards, and it has consistently been at or above 800 despite having gotten over 20 new credit cards over the last nine years. I think a big part of that has to do with having more credit available to me but using very little of it at any one time.

Now that you know the main factors that contribute to your credit score, it is so much easier to understand exactly how to protect your credit score even if you do decide that you want to apply for new rewards credit cards and use those credit cards, of course, in order to earn points. Now first, you have heard me say before and I'm going to say it again. Always pay your credit card statements in full monthly.

Understanding how your credit score is calculated, you can now see why this is so incredibly important. That's because the number one most important factor in determining your credit score is your on time payment history. All always paying your credit card statement in full monthly, of course, including any non-rewards credit cards that you might have will help ensure that this component of your credit score remains strong.

Second, keep your credit utilization ratio low. Again, I know this sounds counterintuitive, but having more credit cards and higher lines of credit on your credit accounts is actually advantageous, especially when you don't carry high balances on your credit cards. The lower your credit utilization ratio, the more positive and impact this aspect of your credit score will have.

Third, keep your credit card accounts open and don't close accounts even if you don't use some of your credit cards regularly. So you should not close credit card accounts even if you don't plan on putting any spend on a specific credit card moving forward. The reason to keep these accounts open is because it helps to maintain the age of your credit history.

If you close a credit card, especially if it's a card that you've held for a long time, that can negatively impact the credit history aspect of your credit score. Many of you will have that one credit card that you've had forever that maybe you don't intend to use as much going forward because it's a cashback card, or it's not a points earning card and now you want to focus your spending on rewards credit cards. That's fine, but just keep the card account open, store it in a secure place like a home safe or a safety deposit box.

Now that you know the truth about credit cards and your credit score, I hope that you'll feel more confident about getting new credit cards to help you earn more points faster.

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Thank you for joining me for this week's episode of Point Me to First Class. If you want more tips on turning your expenses into travel, visit pointmetofirstclass.com to learn more. See you next week.