Sunday, February 03, 2013

Does Churning Credit Cards Damage Your Credit Score?

One of the first things level headed friends ask me when I mention signing up for credit cards (for bonuses) is whether their credit rating will be damaged by playing the game.

It's a smart thing to think about. Our credit scores, and the ability to leverage credit to our advantage, is one of the most important assets we have (the most important being the earning potential our talents afford us).

In researching a bit how credit scores are determined I was surprised how much of what I thought I knew about credit scores was based on hearsay. Or folklore. Or a random collection of tidbits I'd heard over the years.

For sure, I think most of us will be totally fine if we, basically, "behave" when it comes to credit. Take on a responsible amount of debt, pay our bills on time, and have just a few credit cards.

But when you mention signing up for credit cards for bonuses, instinct tells us this will be bad for our credit ratings. Is this true? Let's take a closer look at what's good and bad about signing up for a new credit card.

First, signing up for a new credit card results in a "hard pull" of our credit score. This in itself knocks down our score a few points. But credit scores tend to recover from these checks after a few months.

If you're approved for a new card, it does two things:
  1. It increases our total credit line
  2. It decreases the average age of our accounts
Increasing our total credit line typically helps our credit score rather than hurts it because it's good to have a small percentage of our total credit line in use. If the total of our balances is low compared to how much credit we have access to it's a good thing for our credit rating.

Decreasing the average age of our credit card accounts is bad for our credit score, and it's a real concern when applying for credit cards for signup bonuses.

Here's who goes into determining a credit score (from My FICO):
Our credit cards are just one portion of our borrowing portfolio. A mortgage is of higher importance than credit cards and with lending standards tightening I wouldn't be willing to risk the ability to qualify for a mortgage by fiddling around with credit cards. Even if we already have a mortgage, it's important to have a good credit score in case a refinance opportunity pops up.

Automobile loans and leases are also important. But if your credit score is good, even in spite of signing up for a bunch of credit cards, you're likely to qualify for the most favorable automobile loans and leases.

A consideration adjacent this:

Should we cancel an old credit card (with no annual fee) which we never use? No! Absolutely not. Doing so would decrease the average age of accounts.

So, it's important to:
  • Understand what goes into determining your credit score
  • Get your credit report and make sure there's nothing on there you're not expecting
  • Monitor your credit score with a service like Credit Sesame or Credit Karma
  • Space out your signups over time
  • Pay your balance in full each month
  • Keep your balances low with respect to your overall credit line
Since I do these things I feel comfortable that signing up for credit cards (for bonuses) won't damage my credit score.

In fact, if I wasn't knocking down my credit score a bit by applying for credit cards one could argue I'd be leaving money on the table. How high do our credit scores need to be after all? Just high enough to get the most favorable loan terms. We don't get a bonus for a credit score higher than 760.

It's kind of like in college where there's no difference between barely scraping by with an A and getting the highest A in the class. You'd be better off getting the lowest A possible and devoting your precious resources to other endeavors.

Here are some links for related reading:
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