Too Many Credit Cards is Bad; My Credit Score will Suffer…
Many folks have gotten the message that the use of credit cards is a bad practice. I think of it as the elephant in the room. This stems from the many people out there who have gotten in over their heads by not using credit responsibly. Running up thousands of dollars of credit card debt is not a fiscally responsible practice. I am not advocating this kind of behavior with Travel Hacking.
Successful Travel Hackers handle credit cards very carefully. First, we pay our monthly statements in full. We pay on time or occasionally early every month. There are some who even pay twice a month to keep their credit utilization (more on that in a minute) extremely low.
As I’ve said before, we don’t open credit cards with the idea of spending more than we currently spend now. Overspending is stressful. I can’t state this enough so I hope I’ve made it very clear.
Credit cards are a great tool to help us travel for way less money than those who don’t get into our hobby. I currently have 11 credit cards in my name and expect to apply for more in the near future.
The Value of Making On-Time Payments
Making on-time payments every month has a big effect on your credit score. In fact, payment history represents 35% of your credit score. So one of the best ways to improve your credit score is to make on-time payments every month.
You may be wondering about how your credit score will be impacted by opening up new credit card accounts. Again, there is a misconception that having multiple credit cards will negatively effect your credit score. True, on a short term basis (perhaps 1-3 months) after opening a new credit card, your score may go down as much as 15-20 points. However, in the long run, your score will go back up. My credit score has improved over 50 points in the last 12 months. You’re probably wondering how this is possible.
One of the main reasons scores go up is something called credit utilization. Credit utilization is the percentage of outstanding credit (the credit that all of your creditors which may include mortgage companies, other banks, student loan companies, auto loan companies and credit card companies have extended to you) that you use on a monthly basis.
Very low credit utilization (less than 10% of outstanding credit) is a key determiner of credit worthiness and this helps boost your credit score. I’ve seen it written that credit utilization makes up about 25% of your credit score.
Here is an example of the numbers to help you wrap your head around this concept. Let’s say I started this hobby with $100,000 in outstanding credit.. I used a total of $5,000 in a combination of mortgage, student loan and credit card payments each month. My credit utilization would be 5%. That is: $5,000 divided by $100,000.
This is actually a pretty low number and the banks are happy to extend me more credit when they see this. Let’s say I’ve signed up for two credit cards that each give me a $5,000 limit. This now raises my outstanding credit to $110,000. I continue to spend the same $5,000 per month and my credit utilization is now lower at 4.5% This is now: $5,000 divided by $110,000). I’ve now lowered my credit utilization by half a percentage point.
Note that credit utilization is a constantly changing number depending on exactly how much credit you’ve used at any point in time. Here’s a tip: Right before you apply for a new credit card, pay your credit card bill(s) early. Also make sure the payment has posted before you apply for another card. This will lower your credit utilization which will help the bank see you as a better credit risk for extending you credit on a new credit card.
Length of Credit History
Another factor that goes into your credit score is the length of time your outstanding credit accounts have been open. Remember you can find this information on your free CreditKarma account to see the length of time each credit instrument has been open. The longer the accounts have been open the better you’ll look to the banks. This is why it is never a good idea to close your oldest credit card account.
Ways to Keep Your Oldest Card Open
Let’s say you don’t want to pay the annual fee on the card but want to keep it open. Call the bank and see if you can get the fee waived for a year. If not, the credit card company might offer you an incentive to keep the card open and pay the annual fee.
Another way to keep the card open is to inquire about changing the existing credit card account to a no-fee card. Generally this is a downgrade of the card. This is fairly easy to do and preserves the credit extended on the card. And now you pay no annual fee. I’ll dive into this in more depth in a future post.
The bottom line is that responsible use of credit cards will boost your credit score in the long run. So you see, the elephant in the room is quite benign. Dive in slowly and start reaping the rewards of Travel Hacking.
What other concerns do you have about signing up for new credit cards? What is keeping you on the sidelines of this great hobby?