MoneyUnder30.com
MoneyUnder30.com

Are Rewards Credit Cards Bad For Your Credit Score? The Truth May Surprise You

I’ve have started thinking about using a rewards card but I’m concerned about how opening a new card will affect my credit. Is this a legitimate concern?

Are rewards credit cards too good to be true? What you need to know before applying.After recent articles on how to start travel hacking and the best travel rewards programs for non frequent-fliers, we’ve received a few questions from readers wanting to start taking advantage of credit card rewards for the first time.

One reader asks:

I had credit card debt in the past, so the idea of opening a new card sounded crazy. Now that I’ve paid off my debt, I’ve have started thinking about using a rewards card (maybe the REI card, I buy so much gear from there!) but I’m concerned about how opening a new card will affect my credit. I have an excellent credit score, over 800, and I’m nervous about damaging that. I’m worried that taking out a new card and having more available credit would hurt my credit score. Is this a legitimate concern?

Let’s take the issue point by point and debunk a few common misconceptions about credit cards, rewards programs, and your credit score.

First, the obvious: Even the best rewards card is a terrible deal if you don’t pay your balance in full every month. Unfortunately, many consumers are lured to these cards by free airline tickets or a $200 gift card but end up carrying debt on the cards at 20 percent APR. Money Under 30 readers know better, but I have to say it: Don’t do this. If you need a credit card for emergencies while cash is tight, find a card with a low APR and forget about rewards

Are credit card rewards a scam or a deal?

You know the saying: “if it’s too good to be true…”

When you stop to think, the fact banks can pay us 1 or 2 percent back for every dollar we spend should raise an eyebrow.

The reality is, we all pay a 2.5 to 3 percent “electronic payment” tax on everything we buy. These are called interchange fees; money the banks charge stores to process their cards. Laws, no doubt influenced by bank lobbyists, are supposed to prohibit stores from charging more to use a credit card or less if you pay in cash. Rewards credit cards simply give us a partial rebate of this tax.

So now, rewards credit cards aren’t too good to be true, but they’re not exactly a deal, either. By using one, you just get some of your money back. If you find a store that gives you a 5 percent discount for paying cash, you should probably take it.

Do rewards credit cards hurt your credit?

Probably not, but maybe.

Our reader shouldn’t worry about opening a new rewards credit card, or even two. Provided she’s out of credit card debt and has an excellent FICO score, she will likely be approved for the card.

As you might know from “Credit 101”, every time you apply for credit it counts as a hard inquiry on your credit report. Hard inquiries stay on your report for two years. One or two isn’t bad, but more than that in a short period can raise red flags and lower your credit score because it implies you’re hungry for credit.

For this reason, anybody with so-so credit or credit card debt should not apply for new rewards cards. Focus instead on timely payments and reducing debts to bring up your score.

Our reader is also concerned about adding new available credit to her credit report. But this can actually be a good thing for your credit score because of the debt utilization ratio.

A factor in credit scoring, the debt utilization ratio is:

Total of credit card balances / Total available credit

For example, if you have two cards with a combined $4,000 credit limit and spend $1,000 on one card, your ratio is 25 percent. If you spend $3,000, your ratio is 75 percent. Lower is better because it shows you are not using a lot of credit.

Assuming your monthly spending stays constant, the more available credit you have, the lower your ratio will be.

Finally, there is one other factor that may impact this reader’s credit score when applying for a new rewards credit card: average account age.

Part of your credit score is determined by how long you have used credit (the time since you open your first account) and the average age of all of your credit accounts. Opening new cards reduces your average account age, which may have a small impact on your credit score.

The bottom line is that there’s nothing inherently bad for your credit about applying for rewards cards as long as you’re in a good place to start with. The hard inquires and reduction in your average account age may cause a temporary dip in your credit score, but in the long-term having more credit may actually give it a boost.

About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. This might fall into a more advanced discussion but I believe someone who does not have credit card debt nor plans to carry a balance and has a score at or near 800, someone should actually apply for rewards credit cards.

    Banks constantly have signup offers anywhere from 20,000 points to 100,000 points and when points or miles are used effectively, the value of the rewards reaped from signing up for a credit card significantly outweigh the temporary hit to your credit score. The value of those points are conservatively $200-$1000. If someone has a 800 score, what does it matter if the score drops to 795? Or even 790?

    As long as I keep my score about ~ 760, I’d be approved for the best loans with the best rates as someone with a 800 score. In fact, I think I could argue by NOT signing up for a rewards credit card, I’m costing myself free trips or at the minimum cash back when your score is 775 and up. You might as well make your credit score work for you.

  2. You nailed the pros and cons on the impact to scores. Thanks for a very clear explanation!

    The tax on using the credit cards is not always applied. Most merchants that I deal with charge the same rate for cash and credit. The only exception are gas stations, which offer a discount for cash buyers.

    I prefer using my rewards card as frequently as possible. It saves trips to the bank to withdraw cash, and I get a 30 day grace period where I use the bank’s money for free.

  3. Jon Baggeree says:

    @Kevin,

    The “tax” does not refer to a different price for cash and credit. In fact, if they were always different, this would be a good thing, as you would be able to get the best price possible by using cash. When all the prices are the same, people who use cash have to pay a higher price than they normally would, as the merchant must charge a higher price in order to earn the same amount of money after the credit card company or bank takes their cut. In fact, I believe the rates banks charge are even different for credit vs debt cards, but that difference is realized later during processing so the customer must again pay the same price. If you want to support your local businesses, use cash. If you want to support your wallet, use rewards credit cards.

  4. This was a great post. My wife and I run a blog for millennials who want to travel often and on the cheap and points through credit cards can certainly help make that possible. We know many people with multiple cards, but we usually advise friends just starting out to instead be really strategic about 1-2 good cards per person. The Chase Sapphire for example is a great all around starter card for people interested in rewards. The other part of the equation is helping people understand how to earn points outside of credit cards. It isn’t as lucrative, but little by little, simple things like using reward portals like Ultimate Rewards or AAdvantage shopping as well as signing up for similar dining programs can actually help earn miles!