Reward Cards And Your Credit Score
by Jason SteeleOver at The Consumerist, they have been having a discussion about reward cards and credit scores. Yesterday, someone asked, “Is It OK To Use Credit Cards For Everything, If You Pay Them Off Every Month?” The premise of the question, of course, is that credit cards are evil in general, but that they might be acceptable if you pay them off every month.
The Counter Intuitive Nature Of Credit Scores
What they actually hit on is the odd fact that having more credit cards actually improves your credit score. Let me explain. In the old days, before the concept of credit scores were invented, having a good credit was simple. Back then, people were concerned with your “credit history”. Your credit report was examined, and if you had been paying your bills on time for years, you had “good credit”.
The Rise Of The Credit Score
Apparently, the concept of “good credit” was not a quantifiable value. Different people had different ideas of what “good credit” or “bad credit” was. That is why Fair Isaac Corporation, or FICO, came out with the concept of a credit score, or “FICO Score.” This is a third party that evaluates your entire credit history and spits out a number. Credit card companies and other lenders no longer have to examine your unique credit report, they merely have to decide which loans to offer anyone with a particular credit score.
How Does Having A Lot Of Credit Cards Help Your Credit Score?
The odd thing about credit scores is that they are computed using a secret formula. While this formula hasn’t been disclosed, experts in the field have gotten the gist of it. One of the key components in your score is the amount of available credit you are currently using. Once you understand that, it is obvious why having many credit cards with high credit limits will reduce your percentage of credit used relative to your credit limit.
How Does This Affect Reward Card Users
One of the biggest temptations of a reward card value seeker is to apply for every card that has any bonus. Obviously, it won’t help your credit to apply for dozens of cards. Another factor in your FICO score your number of recent applications for new credit. The credit agencies track applications whether or not you are granted credit. The idea is that someone who applies for many credit cards in a short period of time is someone in financial trouble. Do this, and you will undoubtedly lower your score. The formula used obviously does not take into account that you might just be capitalizing on several reward card bonuses.
Paying Your Credit Card Off Every Month And Your Credit Balance
The Consumerist later followed up on this topic by pointing out an interesting fact; just because you pay off your balance in full every month, doesn’t mean you have a zero balance. I remember one time when I refinanced my house, my mortgage broker showed me a copy of my credit report. It listed several unpaid balances on my credit cards. Initially, I was shocked and insulted. I pointed out that I paid every credit card bill on time and in full, so that must be a mistake. To his credit, my mortgage broker pointed out that my “outstanding balance” is merely my total amount of charges since my last payment, not any reflection of a monthly balance not paid in full.
Conclusions
There are many great reward cards out there, and it is good for your credit score to have more than one. I personally have about five, and I think that getting one or two more will probably help my credit score. Credit cards are not evil. Like fire, they can be a necessary and valuable tool if used wisely, but they can also burn you if you are careless.
The first post the Consumerist wrote on this topic pointed out another fact that I have touched on in the past. Credit card companies want you to have more reward cards because they feel that they encourage more spending. As readers of this blog know by now, reward cards are only for people who are able to pay off their balance on time, in full, every month. Hopefully, those with that kind of spending discipline are not the kind of people who will make unnecessary purchases in pursuit of a 1-5% return.