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This first post is going to discuss the basics of credit scores because it is an important foundation to build before moving on to credit card rewards. Before long though you will be leveraging a great credit score to earn travel rewards through credit cards and loyalty programs.
Most Important Rules of Credit and Credit Cards:
- If you wish to participate in this venture it is of the utmost importance to always pay your bills on time and in full; NEVER PAY INTEREST. Let me put it this way, credit card rewards range from 1%-5%, and credit card interest rates can be as much as 15%-25%. So paying interest would just cancel out any rewards you would earn.
- Never to spend beyond your means for the purpose of earning rewards.
Credit Score Definition:
Credit scores are numerical figures that banks and other lenders use to gauge our reliability, responsibility and creditworthiness as borrowers. Each lender calculates this number based on your past credit/financial activity and repayment history. The number can vary depending on the algorithm that each individual lender uses to tabulate the number. Having an excellent credit score opens up many opportunities in the credit/financial world at the lowest available interest rates. There are three Credit Bureaus that track your financial history to generate the numerical credit score; Experian, Equifax and Transunion.
Credit Scores range from 300-850, with the higher the credit score the better it is and vice versa.
According to Experian the credit scale/range is as follows:
300-579 Very Poor
740-799 Very Good
The higher the credit score, the more opportunities you have. In order to get the most value from treating rewards-driven travel as a hobby, its important that on average you have a very good to exceptional credit score. There are some people that manage to get approved for travel credit cards with less than stellar scores, but being in the very good or exceptional range gives the best approval odds. If your credit score is not up to par yet, do not worry. Credit scores constantly change. The following sections show what needs to happen in order to get your data to its optimum level. In no time you will have the credit score necessary to be a smarter traveler.
Credit Score Factors:
These are the 5 factors that effect how a credit score is calculated, each effecting a different percentage of your score:
1. Payment history is the first one that we will take a look at because it is the one that holds the most weight, at 35%, in terms of how much it affects your credit score. It is essential for lenders to know your payment history so that they can gauge, based on your past actions, whether or not you will pay on time and in full. This is the main reason this element of the credit score calculation holds so much weight.
2. Credit utilization, which accounts for 30%, is how much of your current available credit are you using. It accounts for the second-heaviest percentage because when lenders look at your credit report, if they see that you have high balances on most of your current lines of credit, then they will conclude that you may overextend yourself. The bank then may assume that you will not make your payment or may be late. Most experts say that you should keep credit utilization to 30% or under. The lower that your credit utilization is, the better it is for your overall credit score. I believe that 5-10% is ideal because it shows that you are using your available credit without overextending.
3. The Average Age of Accounts equates to about 15% of your score. Therefore, the longer that your accounts are open and in good standing the better. Think of it as a good unopened bottle of wine, age is a good thing! Well-aged accounts show lenders that you can responsibly handle credit and keep lines open and in good standing for long periods of time.
4. A mix of credit accounts is less consequential, but still relevant as it does equate to about 10% of your score. A various mix of credit lines shows lenders that you know how to handle multiple types of credit, including installment, revolving and open lines. More on this to come.
5. The number of credit inquiries on your report is the last component that affects your credit score, about 10%. These appear on your credit report when you authorize a lender to do a hard inquiry on your credit report before the lender extends a line of credit to you. A hard inquiry usually results in your credit score decreasing by about 4 points temporarily. A soft inquiry does not affect your credit score. This inquiry is sometimes used for services that offer free credit scores (Credit Karma, etc.) and sometimes for credit limit increases.
Credit Score Uses/Types of Credit:
Many types of businesses utilize credit scores for a variety of reasons. It’s important to have a mix of the three types of credit listed below to become a traveler with a great credit score. We will take a look at the three different types of credit and examples of each:
1. Installment Loans are when a large amount of money is lent and each month the recipient pays a set amount. These arrangements are stable loans and they show lenders that you can handle a monthly debt. Examples include: Mortgages, car loans, student loans, etc.
2. Revolving Credit is where a lender provides a set limit and you have the ability to utilize as much or as little of it each month. You can request a credit limit increase but you cannot exceed the credit limit. However you can request a credit limit increase. You can also pay off this type of credit over a period of time, although this usually comes with interest. That typically involves the accrual of avoidable interest. All needless interest is wasteful and counter-productive for the savvy points-driven traveler. It is also important to mention that it is never okay to spend beyond your means to accrue more points. Credit Cards are the prime example of Revolving lines of credit.
3. Open Credit is somewhat of a blend of installment and revolving credit. Open credit is a line of credit, with no pre-set spending limit that can be used each month. It is the bank’s expectation/requirement that this line of credit gets paid in full each month. Examples include: Charge Cards, Utilities bills, etc.
How to maintain a great credit score:
These are a few tips I would point out to help accomplish and maintain a great credit score. Keep in mind, if your score is less than optimal, it does take time for these actions to take effect.
1. The most important action that you can do is to pay all of your bills on time and in full. By doing so each month you ensure that you do not pay interest to credit card companies. In the points-driven travel game, paying interest to the bank negates the rewards that you earn from a credit card.
2. In regard to old credit card accounts: It is best not to close them because as long as they are open they continue to contribute to the average age of accounts. When you close a line of credit, it reduces your average age of accounts, potentially reducing your credit score. Secondly, when you close an account, it can increase your overall credit utilization because your balances now become a larger percentage of your available credit. If you have a card with an annual fee that you no longer find useful, it is better to contact the bank and request a product change to one without an annual fee, thus continuing the age of the account without the annual fee.
3. When it comes to opening new accounts, it is best to space them out. If you try to get too much new credit too quickly, it can look suspicious and desperate. If you have opened a new account, it is best to show responsible spending and repayment on your new account before attempting to get another. When you open too much new credit at one time, eventually the banks may start to decline your application(s).
4. It is important to show utilization on all of your cards, at least every couple months. If an account goes unused for a long period of time, it is likely to be closed by the issuer which can negatively affect your credit score by reducing the age of your accounts. On the other hand, it is important not to have too much utilization that reports on your accounts. I usually try to keep my utilization to less than 10%. This shows that I utilize my available credit but at the same time I am being responsible with the available credit and do not get too carried away.
5. Lastly, it is important to have a variety of open lines of each of the previously mentioned 3 types of credit. Having a variety of lines shows creditors that you are a responsible borrower and can be trusted to repay the money that was borrowed.
How a good credit score is beneficial:
1. One of the biggest benefits of having a great credit score is that you are able to qualify for the lowest interest rates and fees on loans/credit cards. Getting the best interest rate on a big loan such as a mortgage can save you thousands of dollars over the life of the loan.
- When Marshall and I got our mortgage, we put 10% down payment so we had Private Mortgage Insurance (PMI) on our loan. Because of our excellent credit scores, not only did we apply for the lowest interest rate available at the time, we also got a very low monthly PMI amount because the lender realized after reviewing our credit reports and scores that we are responsible borrowers. If I am taking an educated guess, based on online mortgage calculators, we saved about 100-150 dollars per month on the PMI payment alone.
2. Having an excellent credit score also makes you eligible for the best credit cards with the best earning rates, signup bonuses, and perks. When you have a great credit score you are able to leverage it to become a traveler that utilizes credit card rewards to your benefit.
Free Credit Score:
There are websites available that will give you your credit score free of charge. They calculate it using a soft inquiry which does not negatively affect your credit score. Utilizing these free services will help you keep tabs on your credit score so you can utilize it to become a smarter traveler. These websites update your score once a week or once a month.
1. Credit Karma is my favorite website to use when I want to check my credit score. It offers a detailed look at the factors discussed above and whether each factor has a high, medium or low impact on your credit score. One of my favorite features about the website is it offers a credit simulator calculator so if you want to see how a change to your report may effect your score it will provide an estimate of what your score could be. Credit Karma does not require a credit card number in order to sign up. It updates your Transunion and Equifax scores once per week. Credit Karma does offer an app free of charge.
2. Credit Sesame is another website that offers your free Transunion credit score. Like Credit Karma it looks at all of the factors that affect your score while giving a grade on each. Like Credit Karma, Credit Sesame does not require any sort of payment in order to register an account.
3. Credit.com is a similar website but it gives your Experian credit score. Like Credit Sesame it offers you grades on each of the credit factors that affect your score. A unique feature is that it allows you to see where your score falls in comparison to the averages of people your age, in your state, national averages and more.
Free Credit Report:
Everyone is eligible to receive one copy of your credit report from each of the bureaus once every year. This is essential to do so that you can check often that the information on your report is correct. It is very common to find mistakes on your credit report which can negatively impact your score. It is important to check your report on a regular basis. You can get your free credit reports from each of the three credit bureaus from annualcreditreport.com.
Recently I got an email from Credit Karma that a collections account was added to my credit report and my score had dropped 35 points. It was a delinquent medical debt that was caused by a registration error when documenting my home address. Approximately a week after I paid the balance, the collection account was removed from my report, correcting my score. I believe that having these accounts allowed me to catch this mistake early and take care of it relatively easily.
Using the advice given in this post, it will assist you in achieving the credit score needed to become a smarter traveler. Using your credit score to become a smarter traveler can get you free or less expensive adventures.