Understanding How Your Credit Score Works

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One of the easiest way to accrue a ton of miles is through credit card sign-ups. In fact, this year has been a banner year with the 100,000 mile British Airways deal (expired), 100,000 point Amex Platinum Card (expired), 75,000 AA cards (expired) and 50,000 point Sapphire Preferred card (expired). All it takes is a decent credit score and a little bit of time and spending and you can have more than enough miles to travel around the world in first class – several times over. However, there are definite pitfalls to the credit card game, so you have to play smart in order to come out ahead. Luckily the rules aren’t that difficult, but it does take some time to understand what is involved.

The first thing you need to do is understand your FICO score ($19.95- update: search for discount codes). FICO is simply a company that aggregates credit data and sells that information to individuals and companies/banks. There are a number of other credit score companies, like VantageScore, but the most widely used is FICO. It’s a number on a scale of 300-850, with roughly 700 being the average. There are a lot of different opinions on what constitutes very good credit, but it seems a safe bet would be 720, with 700+ being good. Once you are above 720, it generally doesn’t matter whether you have a 760 or 850. Perfect credit is great to brag about, but realistically doesn’t set you apart from people who have very good credit. In fact, many people can still get in on credit cards with mid to high 600’s – it just depends on your income and history with the lender. Remember, the credit card business is extremely lucrative, so the banks want to have new accounts opened and the threshold for which you will get approved for each lender is kept secret. You’ll generally only find out if you apply, but you can research on sites like creditboards.com.

Per the FICO website, the five main factors of your credit score are:
35% payment history, 30% amounts owed, 15% length of credit history, 10% new credit, 10% types of credit

So basically, if you pay your bills on time, only utilize a fraction of your available credit, have longstanding accounts, don’t open too many new accounts and have a mix of credit – you should be fine! However, since the score is calculated on numerous factors, you don’t have to be perfect in every area in order to get new credit. In fact, I’ve noticed credit card lenders relaxing the qualification rules on credit cards greatly this year. I don’t have any real estate or car loans and I haven’t had an issue getting any credit cards this year.

In fact, most people think that applying for a new credit card will drop their score greatly. In fact, that’s listed as a fallacy on the FICO website:
Fallacy: My score will drop if I apply for new credit.
Fact: If it does, it probably won’t drop much. If you apply for several credit cards within a short period of time, multiple requests for your credit report information (called “inquiries”) will appear on your report. Looking for new credit can equate with higher risk, but most credit scores are not affected by multiple inquiries from auto or mortgage lenders within a short period of time. Typically, these are treated as a single inquiry and will have little impact on the credit score.

Per about.com, “Credit report inquiries will remain on your report for two years, but only those made within the last year are included in your credit score calculation. The most recent inquiries have the most effect on your score.” An important thing to note: if you are denied for a credit card, it will not count as a hard inquiry and it will not affect your credit. You do run the risk of being asked if you’ve been denied a credit card recently and some companies may deny you on that basis going forward.

Applying for Multiple Cards: Per the breakdown, inquiries only factor into 10% of your overall credit score, so as long as you are strong in the other areas like payment history and amounts owed, you should be fine to apply for new cards. That being said, I personally wouldn’t recommend applying for multiple cards from the same bank (ex. American Express, Chase, Citi) within the same month – and ideally several months apart:

-Chase usually mandates 1 month apart and even then you may get declined at first, however they are very flexible with reconsiderations and will generally allow you to swap credit lines from other Chase cards.

-Citi has a 6 month limit between applications, though you can usually apply for two cards on the same day. I did just that and got two 75,000 AA cards, Mastercard and American Express, approved with identical (and generous) credit limits.

-American Express is a little more fluid, because they have both Charge (Platinum, Premier Rewards, Gold, Green) and Credit (Blue Sky, Delta and Starwood cards). It is possible to have multiple cards – I know people with Platinum, Gold and Delta cards. As with all card companies, American Express uses a lot of factors to decide how many cards you can have at any given time.
Note: If you have a charge card, your available credit reported will only be the highest you’ve ever gotten your balance up to. This can have a temporary negative effect on your credit if you first charge $10,000 and once your statement closes, it may look like you have $10,000 in available credit and you are using up 100% of it (until the bill is reported as paid in full). So, with charge cards, it may behoove you to have a huge month and pay the bill off so it reports your available credit as a large number.

To further complicate matters, there are three credit reporting bureaus and the information that each has on you may be different. I highly recommend checking your credit report on each and correcting any mistakes by disputing them (there are electronic and manual ways to do that) and all are free once you get your copy of your report which can be obtained at annualcreditreport.com. Each credit card company uses different bureaus in different states, so you can research on creditboards.com which each company uses in your state if you think you may be applying for multiple cards in the near future. The goal is to space out your inquiries to different bureaus if possible.

When to close accounts: This is a tricky subject – for your sanity you will want to close credit cards that you no longer use, but be careful – closing credit cards can hurt your credit! As we saw in the FICO calculations, lenders like to see accounts that have been open for a long time and when you close out a line of credit, you are lowering the amount of available credit, thus increasing your utilization (assuming you have balances). For old accounts, I’d recommend switching them to no-fee cards and leaving them open. Another option is to work with your credit card company to switch around lines of credit when you want to open a new card – you can reduce the line of credit on your old card and shift credit to the new card.

If you recently got a bonus on a credit card and you realize you don’t want to keep the card, I’d recommend waiting at least 6 months before closing it. Credit card companies offer lucrative bonus to bring on new customers that will make them money in the long run. If a credit card company sees you opening accounts to get the bonus and then immediately closing them, you may be banned from that company. Think about it – if you ran a business, would you want an unprofitable customer fleecing you for all you have? Of course not. However, credit card companies do realize that people may not want to keep cards after they try them out, so it can be perfectly acceptable to close or downgrade a card after you get the bonus, I just recommend waiting at least 6 months to do so so you don’t appear to be taking advantage of the system.

How to Improve Your Score: In general, the quickest way is to pay your bills on time and keep your balances low, relative to the amount of credit you have available. If you have had trouble with your credit, I recommend getting it squared away before applying for new cards. While it may be easy to put your head in the sand and avoid it, having good credit is key to many things – such as getting a mortgage or even getting a job – so frequent flyer miles should be the least of your worries!

More reading: An interview with the President of FICO on how to improve your score. I also recommend reading through some of my friend and fellow blogger Rick Ingersoll’s posts at the Frugal Travel Guy. He is an expert on credit cards and has a lot of experience with credit reporting and understanding the boundaries of the credit card world.

If you want a free credit score, you can use Credit Sesame, which will give you a non-FICO Experian score and give you an analysis of your debt. I do get a small referral fee for this service, but since it’s free and simple to use (I checked it out), I feel comfortable recommending it, though nothing will give you a true picture of your credit score like an actual FICO report.


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