I like to tell everyone who will listen about the huge value they can get by maximizing credit cards and using them responsibly. There are so many great credit cards out there, and those who are using debit cards or paying cash are basically throwing money out the window.
When I’m talking to a skeptic about credit cards, there’s one misconception I hear more than any other — “but I heard that applying for credit cards is bad for your credit score.”
Is there any truth to that? At the moment I have over 20 credit cards and my credit score is nearly perfect. Let’s look at how that’s possible.
How your credit score is calculated
Your credit score is made up of the following components:
- 35% of your score is your payment history (the percentage of payments you’ve made on-time)
- 30% of your score is your credit utilization (how much credit you’re using compared to your total limits)
- 15% of your score is your credit age (the average age of your open accounts)
- 10% of your score is the types of credit you use (how many different types of requests for credit you have)
- 10% of your score is your requests for new credit (how many times you’ve applied for credit)
Your takeaway here should be that if you make your payments on-time, don’t utilize too much of your credit, and keep your average account age fairly old, that’s 80% of your credit score right there.
How your credit score goes down when you apply for credit cards
When you apply for a new credit card there’s typically a hard pull to your credit. While the exact impact will vary by person, typically each inquiry will ding your score about 2-3 points. That will fall off your credit score within 24 months. Credit scores max out at 850, so a 2-3 point drop is almost nothing.
But that’s the only consistent downside to applying for cards.
The other potential downside (though it doesn’t have to be a downside) is that your average age of accounts is part of your credit score. Let’s say you previously had just one credit card for 10 years, and you suddenly apply for a new card. Now your average account age will be five years. The way to prevent this from being a problem is to keep a few credit cards open for a long time.
How your credit score goes up when you apply for credit cards
The above cover the limited downsides to applying for credit cards. An inquiry could lower your score by a couple of points temporarily. But you can see huge positive improvements to your credit score when you open new credit cards.
The most basic reason for this is that you’ll have a lot more available credit, and the percent of credit you utilize and your ability to make those payments on-time makes up 65% of your score.
For example, say you currently have one credit card with a $5,000 credit limit, and you spend $5,000 on it per month. You’re utilizing 100% of your credit.
To give an extreme example, say you then have 10 credit cards with a $5,000 credit line each, and you still spend $5,000 per month. You now have $50,000 of available credit, but you’re now only utilizing 10% of your credit.
This will have a hugely positive impact on your credit score. Why? Because it raises a red flag when you’re using almost all of your credit. That’s because card issuers are concerned whether you’re maxing out your credit card.
If you’re using all the credit that you have available, they wonder what will happen if they give you more. Meanwhile if you have a lot of credit that you’re using responsibly, card issuers view that as low risk, because they can see how responsibly you are.
A real life example
I have over 20 credit cards, so let’s take a look at my actual credit score and details. On a scale of 300 to 850, my credit score is 834 and 827 with Transunion and Equifax, respectively. That’s a pretty close to perfect credit score.
Then there’s a more detailed description of what comprises my score:
As you can see here, on the high impact areas I do very well — I have very low credit utilization (apparently 0% — that’s how much available credit I have), I make 100% of my payments on-time, and I have zero derogatory marks. Those are the most important things on your credit report, and my credit utilization wouldn’t so low if I didn’t have so many cards.
Furthermore, my average age of accounts is even really high thanks to the cards I’ve had open long term, which always help keep that number up.
To be clear, my situation isn’t an isolated incident. For example, when I met Ford several years ago, his credit score was in the low 700s. He was frustrated, because that’s good but not great, and he was worried that if he applied for more cards his score would get worse. Well, he has applied for a lot of cards, and his credit score is now better than mine — it’s 838.
Why you might want a lot of credit cards
The logical follow-up question is “okay, you can have a lot of credit cards, but why would you want to?”
Well, first and foremost my goal is for those of you who are exclusively using debit cards to instead switch to credit cards, assuming you can use your credit responsibly (it’s almost never worth carrying a balance on a credit card).
Way too many people only have debit cards, so it’s time to start building your credit and realize that applying for credit cards can potentially help your score, rather than hurt it. Pick up a card like the Chase Sapphire Preferred® Card or Chase Sapphire Reserve® Card, which offer easy to use points and great bonuses on spend.
If you don’t want to get into points, pick up something like the Citi® Double Cash Card, which has no annual fee and offer 1% cash back on every purchase, and then an additional 1% cash back when you pay for those purchases.
But why would you want to have many credit cards?
- First you want some cards that can help you maximize the points you earn for your everyday spend — the Chase Sapphire Reserve® Card offers triple points on dining and travel, the Citi Premier℠ Card offers triple points on travel and gas stations and double points on dining and entertainment, and the American Express® Gold Card offers 4x points at US restaurants, 4x points at US supermarkets (up to $25,000 per year), and 3x points on airfare purchased directly with airlines, just to give a few examples
- Then there are some credit cards that offer annual perks that more than justify the annual fee — The World of Hyatt Credit Card, IHG® Rewards Club Premier Credit Card, and Starwood Preferred Guest® Credit Card from American Express each offer valuable anniversary free night certificates just for paying the annual fee, with no spend requirements
- Then to help build your credit score long term and keep your average age of accounts as high as possible, it can make sense to have some no annual fee cards, like the Chase Freedom® Card and Chase Freedom Unlimited®
There are a lot of misconceptions about credit cards, though probably the most common involves the belief that applying for credit cards will hurt your credit score. This simply isn’t the case, at least if taking a long term approach to credit cards. In the short term you will be dinged a couple of points if you apply for a credit card, though the long term benefits more than outweigh that, including your decreased credit utilization and positive payment history.
Hopefully this inspires at least a few of you with debit cards or limited credit cards to start maximizing your points!