DAY 3 - Your FICO Score and How Travel Hacking Affects Your Credit

 

CREDIT CARDS AND THEIR EFFECT ON YOUR FICO SCORE

 

Note: I am not offering financial advice or soliciting anything via this blog. I am simply teaching all aspects of miles and points, while providing some general knowledge about credit cards. Please consult your financial professional (it might even be me!) about your own personal financial situation instead of just taking my word for it.

 So, you want to apply for a credit card in this journey? Cool. Before you go anywhere, you need to understand how this affects your credit score. The FICO (which stands for Fair Isaac Corporation) is a model that calculates your credit score based on information that credit bureaus keep about you. The three credit bureaus in the US are Equifax, Experian, and TransUnion. Your FICO score from each bureau considers only the data that is kept at each bureau. Meaning that information that TransUnion has about you could be very different than what Equifax says. The score boils down to a three digit number between 300 and 850 that will instantly tell a creditor if you're worthy. The higher the better. How do they come up with this? Let's go over each individual factor.




35%: Payment History. The single largest predictor of your credit score. Do you pay your bills on time? In order to have a good credit score, the number of on-time payments has to be as close to 100% as you can get it. Bankruptcy, liens, collections, late payments--these all negatively affect your score BIG TIME.

30%: Amounts Owed. Simply, this is your debt burden. How much debt do you have in relation to all the limits you have? How much debt do you have on that one card, compared to its limit? How many accounts do you have with balances? How much do you owe across all your accounts? How much do you pay on installment loans per month (mortgage, car) and would that keep you from paying your credit card bills? As far as creditors are concerned, they want to see you have less than 30% debt to limit ratio, not just on each card, but across all your cards as a whole (BUT YOU SHOULD HAVE ZERO, you know this!) So this means, if you have a card with a $1000 limit, you should never have a balance of more than $300 on it at any one time. Similarly, if you have 5 cards with $1000 limits, a total of $5000 in credit, you should not have more than $1500 charged altogether.

15%: Credit History. As each card gets older, it has a positive impact on your score. There are two metrics used here. What is the average age of all your accounts? What is the age of your oldest account? Closing an account less than 10 years old does not affect your score because accounts stay on your credit report for 10 years from opening no matter what. Opening newer accounts tends to make this score go down, because you are lowering the average age of your accounts. So, keep your oldest card around so that you have the credit history to bump the average age up. For millennials like myself, the only real thing that helps us in this factor is time.

10%: Types of Credit. You benefit by having a history of managing different types of credit. Cards, mortgage, car, student loans, etc. Creditors will see you as low-risk if you have proven history of managing all kinds of debt.

10%: New Credit. These are called "inquiries." When you apply for a card, this can temporarily hurt your score, usually by about 3-5 points or so. If you're "rate-shopping" with banks for a car loan, mortgage, etc., usually the bureaus will combine all inquiries for credit within a short time frame (either 14 days or 45 days depending on the bureau). So you should only see one hit if you do all your shopping at once. Mortgage, car, and student loan inquiries do not count at all in your FICO score if they are less than 30 days old. However, any credit card inquiry will be considered an inquiry.

There are two different types of inquiries--hard and soft. Credit inquiries that you made such as pulling your own credit report, employee verification, or by companies initiating pre-screened offers of credit or insurance do not have any impact on a credit score: these are called "soft inquiries" or "soft pulls", and do not appear on a credit report used by lenders, only on personal reports. Soft inquires are not considered.

Hard pulls stay on your report for 24 months, after which they drop off. However, they are only considered for scoring purposes for 12 months. So if you applied for a card in March 2014, the hard pull is still on your report, but is no longer counting against your score. Usually, once these hard pulls expire, people's credit scores jump back up to where they were or higher.

I know what you're thinking: Wait, didn't you say that you applied for dozens of cards?

Yep, that's true. Travel hacking by credit card has led me to have a credit score that hovers somewhere around 750-780 depending on the bureau. That's really really good for a 25 year old. There are older folks than me in this hobby who have more cards than me, and scores in the 800s, likely because they have other types of credit they've used responsibly, like car/student/home loans. My credit score is high enough that I have no problem getting approved for any card I want. Once I cool off the hobby and let the inquiries portion drop off my report, I should have no problem getting the lowest interest rate on pretty much any loan.

So let's sum it up....

1. Applying for a credit card hurts your credit score. In my experience, my score drops 2-5 points per hard credit pull. These hard pulls stay on your credit report for 24 months.
2. Getting the new credit line that comes with a new credit score raises your credit score. Your credit utilization ratio of debt-to-credit-line gets lower (which is good) when you open a new card but don’t spend more money per month on your card than you can afford to pay back in full each month.
3. Closing a card has no effect on your credit score if the account was less than 10 years old.
4. Making on time payments raises your credit score. This is the most important part. 

 

 CHECK YOUR CREDIT REPORT!

 

Do you know what your credit score is? Have you checked each bureau for accurate information? I read somewhere that a large minority of us have incorrect information at one or more bureaus. Fix it!

Start by going to annualcreditreport.com. This is the ONLY site where you can get a free report, without any strings. You can get one free per year from each of the bureaus. I like to get one report every four months, so that I space out all three over the course of a year. Whatever floats your boat.

These reports do NOT include your credit score. They only include the information they've used to generate a score. You just need to make sure that the information is accurate so that no one steals your identity! (Living in Florida, this is the most fucked up ID theft state in the country, so it's imperative here more than anywhere else!)

What if you want to see an actual number? You can get a general idea of what your score is from several websites for free, also with no strings attached, no credit card needed to sign up. These are what the card community calls FAKO (not true FICO) scores, but they give you a close approximation, given the bureau used to compile your information. Some even give you your free credit report as often as every month.

Equifax: www.creditkarma.com & www.quizzle.com
TransUnion: www.creditkarma.com
Experian: www.credit.com & www.creditsesame.com

Sorry for such a long post, but this stuff is super important, as I mentioned before... credit is the bread and butter of this hobby. If these items are not in order, then travel hacking isn't going to work for you.

You need a score of at least 700 to get approved for most offers out there.

 

If that's not you, then you need to get to work on your score before trying to apply for anything. Many credit card companies offer two versions of the same card, such as a regular VISA and a VISA Signature card, where the Signature gets the signup bonus, and the regular doesn't.

Hope this cleared up any misconceptions or questions you might have had about credit. Tomorrow, I will get into some fun stuff like:

What are the three things I look for in a credit card?
How do I double my miles with business cards?
How long do I hold my credit cards?
What about annual fees?

Thank you again for reading! Peace, love, and an extra pack of peanuts,
LC