The Ultimate Guide to Reward Travel: Chapter Four
The most detailed guide to earning and using frequent flyer miles, hotel and credit card points for reward travel.
What You’ll Learn in Chapter Four
- How credit scores work
- Why reward travel is safe for your credit score
Everyone knows credit is important. For most people, that’s almost all they know on the subject. The rest is misinformation, tall-tales and fear. Most people think that applying for a credit card is bad for your credit score. Is it? Find out how credit actually works.
4.1 How credit scores work
FICO is the company that calculates your credit score. There are a few other companies that can do it, but most of the time, it’s FICO. FICO scores range from 300 on the lowest end to 850 on the highest. Anything above a 700 is considered good to excellent.
Scores move up and down all the time, like literally every month your score is likely to be a few points higher or lower than it was the month before. There is a complex algorithm with thousands of variables that go into the score calculation, but it all boils down to 5 primary factors:
Payment History (35%)
Have you paid your bills on time? Have you ever missed a payment? This is the single largest measure of your credit score and it is easy for you to control: always pay your bills on time. Also, don’t be late! Lastly, make sure you pay all your bills. On time. Are we clear?
Amounts Owed (30%)
Simply put, do not max out your credit cards and always pay your balance in full each month. Opening new cards usually improves this part of your credit, because each new card comes with a credit limit that you could potential draw from. That lowers the ratio of how much you owe to how much you could potentially borrow, and that improves your score. Just don’t actually borrow up to the new limit!
Length of Credit History (15%)
How long have you had credit? If you’re just starting out in the “real world” and do not have credit history, you’ll suffer in this category. It’s also very easy to fix by opening new cards and using them responsibly. Literally doing nothing but having open credit cards or other loans with on-time payments or even zero balances maintained over time increases your credit score. On the negative, if you do have many years of credit history, opening a new card will bring your average age of credit down. Importantly, you don’t ever want to close your oldest account if you want to maintain a high score!
Credit Mix (10%)
Mix of credit cards, loans, mortgage, etc. If you don’t have any lines of credit, or if you don’t have enough variety of credit cards or other credit, you’ll suffer in this category.
New Credit (10%)
Opening new cards does have a small, temporary, negative impact on your credit score. This is one of the lowest percentages of what makes up your credit score and is often outweighed by responsible credit card usage. The impact is lessened over time and after years, it’s completely removed from your report.
We highly recommend you check your credit score routinely at creditkarma.com. This is a free service and checking it does not have an impact on your credit score. For a more in-depth review, the federal government provides one free credit report per year at annualcreditreport.com.
4.2 Why this is totally safe for your credit score
We advocate for smart personal finance strategies that allow you to earn a lot of reward points in a short amount of time. That usually involves getting one or more new credit cards per year. Sometimes, that scares people. But if you understand how credit works, you’ll see there’s nothing to be afraid of! It’s better to be smart than scared, so let’s get smart about why it works that you can get multiple credit cards and still have a near-perfect credit score (like we do)!
Your credit score is made up of five categories, as you can see above. Opening credit cards hurts the least important of any of these categories, and that impact is temporary. It disappears after time.
On the other hand, opening a new credit card helps a larger category, and that impact is a permanent benefit. As long as you maintain the same credit usage and don’t close accounts that would reduce your available credit too much.
So, start with this takeaway: the simple act of applying for even several new credit cards will not have a significant negative impact on your score. It could go down a few points, especially if you already have a lot of available credit and not a lot charged on your cards because the benefit of the additional line of credit will be lower. Often, we see credit scores go up after applying for new cards, but again not by much. Up a few or down a few, it’s important to know that this isn’t the part that matters most for your credit score.
Key to Good Credit
The key to a high credit score is to be a responsible credit card user. Know your credit score prior to starting a rewards application plan. If you do not have at least a 720 credit score, then you will want to work on improving your credit score prior to attempting to opening many new cards. You might not qualify, so you’ll have the downside of a few points lost on a new application, without the upside of receiving the additional credit limit. And it doesn’t help you anyway because you won’t be earning the points that you’re after to begin with! So get a high enough score that you can reasonably expect to qualify for premium cards.
Responsible credit card users:
- Never carry a balance
- Always spend within their budget
- Always pay credit cards in full before payment due dates
- Never miss a payment
As a result, they will never pay interest. And coincidentally, you won’t be applying for an excessive amount of cards in most cases, because you’re only applying for an amount of cards that you can meet the spending requirements for within your current spending.
If you’re a baller and can afford to spend more than $10K a month, you’re enough of a business machine that you probably should have many cards to spread that spending on! If instead you spend something like $2K a month, that’s enough to support a couple of cards at a time and still earn the sign-on bonuses. Responsible credit card users understand the positive impact that credit card usage has on their credit score and understand that opening a credit card here and there does not negatively impact their credit score for the long run. So now that you know, you don’t have to be afraid. It’s math, not magic!
4.3 Credit score example
Let’s say you have 1 credit card with a $5,000 limit and your average monthly spend on that card is $1,000. Your amount owed is 20% ($1,000 balance / $5,000 limit). That utilization rate contributes to 30% of your credit score. You are a responsible credit card user and only spend what you can afford and you pay the balance in full each month. Your payment history – largest piece of pie at 35% – is therefore excellent. You decide to open a new card that also has a $5,000 limit, bringing your total limit to $10,000. But you’re still spending only $1,000 because you’re a responsible credit card user. By adding a new card to your portfolio, you’re now only utilizing 10% of your available credit ($1,000 balance / $10,000 combined limit), so you’re improving the second largest piece of the credit score pie. See how responsible credit card usage and responsibly opening cards can positively impact your score?
4.4 How often can you do this?
As we’ve learned, opening credit cards is not inherently bad. In fact, many people see an increase in their credit scores when they open new credit cards. RewardStock employees (and their families) regularly have 7-10 open cards and have 800+ credit scores. If you have a good credit score (720 and above), there is no long-term negative impact from opening 2 or 3 cards in a single year. In fact, this is a conservative approach and is the model that we use. You could, as many people do, open many more cards and still not have a problem. It’s really about what you can keep up with. 2 cards is an easy thing to manage. 10 is a bit more complicated!
The great part is that you can do this as often as you want. If you want to earn free travel every year, you can. You can gear up for a big trip every other year. Or you could just want to dabble with trying it once and stopping after you get that first free trip (in our experience once you go free you never go back!). The choice is yours. We like to highlight that really is a choice. If you want to claim the rewards, you can. If you don’t, you’re deciding to leave that value on the table. How much you get out of it is based on how much you want to get out of it (and having the right strategy).