Credit Scores & Random Thoughts

A few nights ago I was having a conversation with my wife regarding why I pay everything with my credit card. After being married for 4 months, we are in the final steps of merging all of our finances (this process was not easy for us, but that’s another story for another time). Anyway, I digress.

The Dave Ramsey Theory

We started talking about a recent conversation she had with a co-worker regarding Dave Ramsey who teaches financial management techniques to people around world. If you don’t know who he is, feel free to look him up. In summary, he takes a very conservative approach to personal finance. He teaches concepts like “envelope budgeting” where you set aside cash for specific expenses in envelopes at the beginning of the month. Now don’t get me wrong, there are definitely people out there that probably should follow his methods. The concepts behind his methods are good (i.e. don’t spend more than you have). However, Ramsey also preaches that credit cards and all things related are basically the worst things ever.

Credit Scores/Reports

Maintaining and monitoring your credit score is important. I use to check my reports on a bi-weekly basis. I also receive free FICO credit scores from my American Express and Discover credit cards. As the graphic above shows, your credit score is based on all the following categories. The most important of which are: payment history and amounts owed. These two categories alone account for 65% of your score. What this boils down to is that you should always make your payments on time and you should never carry a balance. If you’re going to get into the travel hacking game, you never want to be charged interest on your balance. This means paying the full statement balance every month.

To take it a step further, I often pay off my balance before the statement closes. This means I only have about $0-100 on my credit card statements that are reported to the bureaus. This keeps my credit card utilization % relatively low. It is also important to look at credit card spending as money that you no longer have. I’ve heard of way too many people getting into debt because of the credit card spending habits. Whenever I make a purchase on my credit card, I mentally set aside that amount in my head as money that I need to pay off my statement at the end of each month.

Average Age of Accounts

One of the most frequent questions I get from people is… “Doesn’t applying for all those credit cards hurt your credit score?” The answer to this question is yes and no. In the short term, my credit score usually takes a hit when I apply for a new card. This is because it lowers my average age of all my accounts (a term known as AAoA). This is why you never want to cancel your oldest card. My score also takes a small hit from the hard pull/inquiry that the bank makes on my credit report when applying for a new card. Overall, my credit score usually drops about 5-10 points. It usually bounces back up after a month or two. If you look a few months out, your credit score can actually increase with the acquisition of a new credit card. This is because your utilization decreases when you have more credit available to you.

Catch 22

Another aspect to consider is the idea that having a good credit score is only useful if you utilize it. In some ways it is kind of a catch 22, in the sense that using your credit score decreases in the short term. However, if you never use your credit score (to apply for loans, credit cards, etc.) what’s the point of having a good one? One of the main uses for your credit score is getting a home mortgage. For this reason, I plan on not getting any new credit cards for 1-2 years before I apply for our first home mortgage. This will ensure that my credit report is relatively clean by the time a bank pulls it to see what type of mortgage I qualify for.

I watch, monitor, and track my credit score more than the average person. My credit score definitely matters to me, but I’m willing to let my credit report drop, albeit temporarily, by 5 points to get a credit card sign up bonus that is worth ~$500.