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Maximize Your Rewards Without Hurting Your Credit

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A credit card issuer is tempting you with the promise of big rewards if you open a new card. Should you bite? Or will the new cards hurt your credit?  A reader I’ll call “Kate” recently asked us:

I receive offers in the mail offering large numbers of points for opening an account.  I want these points for flight upgrades.  I have 3 bank cards now with total credit limit of $30,000 and a balance of $6000.  I want to close the two with no balance and accept two of the cards offering high points. I’d close two only because I thought having a net gain of 0 cards would be better credit score wise.  I know the inquiries decrease my score.

At any time of the month, the balance could be $5000 to $15,000 (the highest ever) and I pay it in full monthly.  What would be the best way to get these points by opening new accounts?

If you’re going to use a credit card a lot — like Kate does for her small business — and you can afford to pay it off in full each month, it’s smart to choose a card that will reward you for all that activity. But opening and closing new accounts can affect your credit scores; and everyone, including small business owners, needs to protect their credit scores.

[Free Resource: Check your credit score and report card for free before applying for a credit card]

Free Tool: Credit Report CardOpening new accounts doesn’t necessarily mean your credit scores have to suffer. Scott Bilker, whom I featured in my story How to Lower Your Credit Card Interest Rates, is a pro at maximizing rewards. He has some 50 credit cards and maintains a strong credit score. While his is an extreme example, it does show that having multiple reward cards doesn’t have to hurt your credit.

For the nitty gritty on how Kate and other consumers can protect their credit in this situation, I turned to Barry Paperno, community director of Credit.com and a credit scoring expert. He first explained that Kate’s thinking here — “I’d close two only because I thought having a net gain of 0 cards would be better credit score wise” — misses the mark. Instead, what she should be concerned about is the impact that will come from changes in her “utilization ratio.”

Crunch the Numbers

To determine the utilization ratio, you add up your balances on your credit cards and divide that number by your credit limits. You’ll need to look at that ratio for each card individually, as well as in the aggregate. Generally speaking, the greater your utilization ratio, the greater the negative impact to your scores.  A utilization ratio of 20%, for example, is going to earn a better score than one at 60%.

Right now, Kate’s overall utilization ratio ($6000 divided by $30,000) is 20%. That’s pretty good. “If you are under 25% you will generally be OK. Ideally you want it to be below 10% but you can do well at 25%,” Paperno explains.

He went on to suggest a couple of different scenarios to help explain how scoring models may look at Kate’s utilization ratios:

Scenario 1: Each one of her current cards has a $10,000 limit and she has a $6000 balance on one of them. Ignoring the new accounts for a moment, the one with the balance has a utilization of 60% while the other two are zero. That’s not ideal, since the score looks at both individual and aggregate utilization. But still, her overall ratio is 20% which isn’t bad. “But if she closes the two with zero balances, she ends up with an overall utilization of 60%. That’s not good,” Paperno warns. “Anytime you are over 50% you should be concerned.”

Keep in mind that closing an account with a zero removes it from the utilization calculation. That means that if any accounts list balances (even balances you plan to pay off in full), those balances will be closer to your limits, and affect this important ratio.

Scenario 2: The $6000 balance is on a card with a $20,000 limit and the other two are at $5,000 each. In that case, the utilization on the one with a balance is 30%, which isn’t nearly as bad as 60% in the previous example.  “There is a big difference between a card with 60% and 30% (utilization),” says Paperno. Still, if she closed the other two accounts her overall utilization ratio would increase from 20% to 30%, which is less than ideal.

[Related Article: The Credit Card Rewards Guide for Back-to-School Shoppers]

Scenario 3: She leaves her current cards open and just adds two new accounts. In that case, her overall utilization can only improve. As long as the accounts she wants to close aren’t charging annual fees, this may be her best approach. She can even cancel two of her existing cards as long as her new cards have limits equal to, or higher, than the ones she will close.

That’s not the end of the story, though. Kate’s credit scores will be impacted another way: by the new accounts. New accounts affect your credit scores in a couple of different ways:

Length of Credit History: This section accounts for about 15% of your score. Here, scoring models typically look at the average age of all your accounts and new accounts will shorten that number. The good news is that closing accounts won’t remove them from this calculation. As long as they are on your credit report, they will be included when the length of the credit history is calculated.

New Accounts: This section accounts for about 10% of your score and it includes inquiries, as well as accounts you have recently opened. “Just the fact that you have a brand new tradeline indicates you are higher risk,” says Paperno. But he adds that, “You can recover those new points just by paying on time. ”

If all these numbers leave you with your head spinning, just keep in mind that, whenever possible, it helps your credit score to:

  • Keep your balances low in comparison to your credit limits,
  • Leave accounts open unless there is a good reason (such as an annual fee or cosigner) for closing them,
  • Open new accounts sparingly.

If Kate plays her cards right and carefully monitors her credit during this process, she may come out ahead with a boatload of new reward points and a positive impact to her credit scores.

[Credit Cards: Research and compare credit cards at Credit.com]

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