Misconceptions of Credit Scores

When it comes to credit scores, I usually hear one of the following three things: (1) your credit score isn’t very good because you don’t have a long credit history, (2) it hurts your credit score to close a credit card, and (3) your credit score is really good because you don’t have any credit cards or debt.

False. False. And very false.

We’ll cover a few topics today. First, we’ll discuss the benefits of having a credit card and why you need to get one. Second, we’ll learn what calculation is used to derive your credit score. And lastly, I’ll help you make a plan for how you can actively manipulate your credit score into the 800+ club.

If you don’t have a credit card, you need to get one now — see our recommend cards at the end of this article

Only one type of person shouldn’t use credit cards. If you are irresponsible and can’t control your spending, please do not get a credit card. Really, this isn’t meant to be a jab. Recognizing that you buy things too readily when you don’t have the money is the first step to changing. We want you to eventually enjoy the benefits of credit cards, but today is not that day. We’ll help you get there though.

 

Benefits and Free Money

For those of us who have more self-control, credit cards are the best thing to ever happen to millennials. We’re entitled and we deserve free stuff. So the world gave us credit cards. As long as you are paying your card balances in full each month, it doesn’t matter what your credit card APR (interest rate) is. Using a credit card makes you feel like every day is your birthday. Free money and rewards, everyday. Generally, credit cards offer the following benefits:

  • Extended warranty up to an additional year. So if you buy or receive insurance for a big electronic purchase you made recently on your credit card, your credit card will double that warranty horizon. For example, your iPhone has a one-year warranty and your credit card will extend that warranty for another year for free automatically.
  • Automatic car rental and collision insurance. Don’t waste money buying insurance from the rental agency! Your credit card provides this for you free of charge.
  • Trip-cancellation and -adjustment insurance. If you get sick before an airplane flight and are unable to make your trip, your credit card will reimburse you for your cancellation fees, for free.
  • Purchase price protection. If you purchase any product and see the price for that item drop a few weeks after you bought it, your credit card will match this lower price and refund you the difference. Literally free money.
  • Security. If you notice fraudulent activity on your credit card, your bank will cancel the charge, reimburse the associated value, and send you a new credit card. I’ve had to use this once, and it was a game-changer.
  • Promotions. I can’t tell you how many times I’ve received free Uber credit from my credit cards running promotions. There are always several promotions for various brands.
  • Sign-up rewards and continuous spending rewards. You can earn rewards regularly worth more than $500 in the first three months of opening a credit card, and you’ll earn about 2-5% cash back thereafter. Again, free money. Millennial heaven.

 

This is just the beginning. Credit cards have saved me thousands of dollars over the last couple years. More important than any of these benefits listed above, though, is building your credit score. Without credit cards or other lines of credit (mortgage, auto loan, student loans, etc.), your credit score will suffer. Maybe you think your credit score is inconsequential, but maintaining a solid score can actually save you $10,000+ over a few years. When you apply for loans and mortgages, credit lenders will evaluate your credit score to determine what your interest rate and terms will be. Maintaining a credit score in the 760-850 range will ensure that you receive the lowest interest rates and best terms. As your score decreases below 760, you risk higher interest rates, costing you tens of thousands of dollars. Check out this chart I made of national averages for mortgages and car loans below to help depict what I’m explaining:

Wow. Even “good” credit scores in the range of 700-759 will cost you $12,000 extra in interest payments by having a higher APR. And with your auto loan, you’d pay $1,500 extra over a five-year period. Just take a look at the total interest paid for those with lower FICO credit scores! It’s ridiculous! And the worst part is that these interest rates aren’t really negotiable. Now can you see why I have an affinity for credit scores?

 

Maximizing Your Credit Score

Credit scores are so fun. I think of mine like a chess game. Every action I make, my credit score will have a response. Just as in chess you can guide your opponent to respond with certain moves, so can you direct your credit score to fluctuate according to your actions. In chess, your opponent can be really good and unpredictable. Thankfully, for us, credit scores are VERY predictable and can therefore be easily manipulated. Here’s an overview of how your credit score is calculated, before I teach you how to manipulate yours.

Credit scores are influenced by 5 factors. I’ve listed each one below with its exact impact weighting on your score.

Payment History (35%)

Do you make your credit card and installment loan payments on time? Excellent credit scores must make 100% of their payments ontime.

Credit Utilization (30%)

Do you carry a credit card balance each month, or do you have any installment loans to continue paying down? Amounts owed is a percentage of your available credit. For example, if my credit limit is $10,000 and I have $1,000 as my credit card balance, my credit utilization would be 10%. Excellent credit scores keep their credit utilization under 9%.

Length of Credit History (15%)

Average age (months open) of all of your open and active lines of credit. When you close a credit card, most credit lenders ignore this cancelled card on your credit report. Excellent credit scores have an average length of credit history of over 9 years. Give me a break, this isn’t happening while while you’re in your early 20’s.

Total Accounts and Credit Mix (10%)

How many combined open and closed lines of credit have you ever had? Both installment loans (mortgage, student loans…) and credit cards. Excellent credit scores have over 21 open or closed accounts. That’s wild. Unless you’re churning credit cards. It’s worth noting as well that having a variety of credit like cards and loans also increases your credit score.

New Credit and Credit Inquiries (10%)

How many new lines of credit have you opened in the last 6-12 months in proportion to your “older” credit accounts? How many hard inquiries have you had in the past two years. Hard credit inquiries happen occasionally, depending on the bank and line of credit you’re applying for. Not every new credit card or installment loan requires a hard credit pull though.

 

Time for a Confession

Let’s go back to the beginning of this article when people were telling you that closing a credit card is bad for your score. They should really stop talking. If that credit card’s age is lower than the average credit history length of all your cards, you will actually see an improvement in your length of credit history as your average age increases. What about the people telling you that you can’t have an excellent credit score with a short length of credit history? Lol. Take a look at a screenshot of my score below.

My Age of Credit History is AWFUL. **Wow, I can’t tell you how relieving it is to get that off my chest.** But yet, I’m still cranking out a 790, putting me well over the Excellent credit score threshold. So, want to learn how you can grow your credit score? The first thing you need to do is sign up on Credit Karma so you can check your credit score regularly. I’m a little obsessive and probably check my score 3 times each week. Never sign up for one of the credit cards they recommend though; they’re usually pretty useless cards.

From the credit score weighting factor I touched on earlier, it’s clear you should take the advice of—literally—every investment banker: “Grab the low-hanging fruit. Twenty percent of your efforts will result in eighty percent of your gains. Buy low, sell high.” Basically, this translates to… pay off your entire credit card balances in full and on time each month. I pay my credit cards from my checking account EVERY week. Doing so will already guarantee that you have secured 65% of the credit score weighting factors. You can expect that paying ontime and in full each month to bring your score to a 720+, ignoring all other credit factors.

We’ll discuss manipulating the other credit factors—credit age, total accounts, new credit, and hard inquiries—next week. I’ll guide you through getting a new credit card, whether it be your first or your twentieth. I’ll teach you about credit card churning and provide you with some helpful templates to keep your credit cards and payments in order. You’ll have the tools to begin conservatively earning $5,000+/year in cash-equivalent credit card rewards. Credit churning can definitely be for everyone. Have you ever seen those people who claim to travel the world continuously and all for free? Well, they’re credit-churning fiends. Or they’re probably just using our Premium platform Credit Cache.

 

If You Read This Post and Don’t Get a Card Below, You Probably Messed Up

If you’re getting super stoked about getting a new credit card, here are the best cards that I recommend with direct links to their offers!

  1. Chase Sapphire Preferred® Card
  2. Chase Freedom
  3. Marriott Rewards® Premier Plus Credit Card
  4. Hilton Honors American Express Credit Card
  5. Ink Business Preferred℠ Credit Card

We want to hear which card you apply for! Message me at chad@wallstreetminimalist.com once you’ve applied and are approved for a card above, and I’ll brief you on more of the benefits of that card! Earning points is only half of the game. Redeeming them correctly is the other half. You can’t really go wrong with any of these cards. Comment below and tell me what you’re most interested in: conservative credit card usage with 1-3 credit cards, or credit churning with 15+ credit cards!

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2 Comments

  1. I normally keep just one or two cards and maximize purchases to reap rewards. I just got the capital one venture for flight miles. I also have the Citi double card. Should I close that one now? Reopen another?

    • Wall Street Minimalist

      If you only have the Capital One Venture and the Citi Double Cash cards, we would recommend keeping the Citi Double Cash card open. It’s important to keep one of your cards open as long as possible to improve your credit history length, even if you never really use the card.

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