All About Credit Scores – Part 2

This is the continuation of my previous post, on what you need to know about credit scores. Click below if you haven’t had chance to read the first part

All About Credit Scores – Part 1

In the previous post, I briefly introduced to you what is credit score, how does it affect you, and the factors that contribute to your credit score. In this part, I will be talking about how to apply credits while maintaining your score.

Let’s refer back to the pie chart again

Credit_Score_Chart_small

When applying for credit cards, amounts owed, length of credit history, and new credit are the ones you should be paying attention to. Let me explain with a scenario:

Initially Bob has two credit cards that he has been using for 5 years, each with a $5000 credit limit, an average monthly spending of $4000 in total, and now Bob wants to get in the game and start traveling on points. So what he does is he applies for two cards for $5000 limit each, after the first month, he gets 50,000 in total signup bonuses. Awesome! Now let’s take a look at what’s changed to Bob’s credit.

He now has a total credit limit of $20,000 across 4 cards, assuming he maintains his spending habit with $4000 per month. His credit utilization actually decreased after the card application, this is making a positive impact to Bob’s credit score. Chart below blue portion represents used credit, and orange portion represents unused credit.

creditutilization

Average length of credit history will go down, because initially he had 2 cards with total of 10 years of history. After the application of two additional cards, Bob now has 4 cards with total of 10 years of history, therefore his average length of credit history is now half as to what is was before. Rest assured this portion of Bob’s score will not be reduced by half linearly, though it may go down 20-30 points.

The two application of credit cards will likely have a hit on Bob’s credit score. One exception is that if one already has a relationship with a lender, and has been pre-approved for a credit card. For example, I do my day-to-day banking at TD Bank, when I applied for TD Aeroplan Visa Infinite, a credit check was not performed because they already have information on my financial background. Another point to consider is that all credit inquires made within a 2 week period will be counted as a single check, this is why people apply for cards in waves. Personally I apply 4-5 cards within a week, to keep the impact minimal.

So what can Bob do so that the impact to his credit is minimal? This can be done by having several free cards to ‘balance out’ the impact of the new cards. Let’s assume Bob initially had 8 cards, each with 5 years of history, totaling 40 years. After two applications, he ends up with 10 cards, still totaling 40 years, but now the average is only down to 4 years from 5 years, which is a less significant impact. Also as a rule of thumb, never ever cancel your oldest card. Chances are, the first few credit cards you have in your life are cards without annual fees, therefore it doesn’t hurt to keep them, as they will make a positive impact to your credit history! If you don’t have them, get some, and use them once every few months will do.

You should also note that you should never cancel a card before it reaches 6 months old, as it will have an ‘R0’ on your file, this may damage your credit history as well as your relationship with the credit card company. What I recommend you do to is to cancel around the 9-12 month mark to avoid annual fee. Then wait for at least 6 months before re-applying.

In summary, what you should do when doing credit card application run are:

  • Keep your old cards in file and never cancel them. Even if they just sit in the drawer
  • On application sprees, make sure you apply for everything within a 2 week period
  • Apply for cards with no annual fee, not only do they lengthening your average credit history, they also boost your credit utilization ratio
  • Actually use the cards, most of these cards come with a wide array of benefits and insurance package. At the same time, you’ll also earn miles and points that go toward your flights

What you should NOT be doing:

  • Applying cards on a random pattern throughout the year
  • Canceling a card too soon, canceling right after you get the signup bonus may damage your relationship with the credit card company
  • Losing track of due dates and renewal dates. With many cards in your portfolio, it is important to keep track and remember when to pay off your bills. Missing a payment can damage your credit history!
  • Abuse the system. Yes, some credit card companies offer generous signup bonuses for new applications, but they do not want someone that does just this once a year and then toss the card into the drawer. I encourage you to actually use the card, maintain a good relationship with the issuer.

Note also that while the score may dip on your first wave of applications, as you use your card throughout the year, it will come back up. Personally, I do 2 waves of card application spree each year, applying for 3-4 at a time. My credit score hovers between 720-760, doesn’t get much below 720 nor much higher than 760. To me this is perfectly acceptable for what I’m getting in return. It may be worthwhile to pay a fee once a year to review your credit file and score. Just to make sure that your score is still in an acceptable level, and also to identify if there are any errors so that it can be reported and corrected in a timely manner.

I hope by now you have a better understanding of how the system works, and perhaps more confident in leveraging credit card signup bonuses to build up your points portfolio. The two cards that I usually recommend beginners to apply for are the American Express Gold and the American Express Aeroplan Gold card. Check them out under my Credit Card Review section!

 

3 thoughts on “All About Credit Scores – Part 2

  1. Pingback: All About Credit Scores – Part 1 | Travel For Less

  2. Great read!

    2 questions:
    1. What does “RO” mean?
    2. What happens if I never cancelled my old credit card and when they send me a new card I don’t bother activate it?

    Like

    • Hey Susan,

      1. It’s actually ‘R-zero’. It just means the credit line has been terminated within 6 months, which may make creditors question your motive on opening the card.

      2. If you never activated, then it will show up on your credit file as inactive. The end date would be the expiry date of your old card.

      Like

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