Since March 2016, my wife and I have been traveling all over the country and the world…for free. Okay, maybe not entirely free, but we travel at a heavily discounted rate. All of our domestic flights are free. Most of our hotel stays in the country are free. All of our international flights are discounted. We’ve traveled to Bali, New Zealand, Dallas, Chicago, Denver, San Francisco, Seattle, Cleveland, Austin, Iceland, France, New Orleans, Belize, New York City, South Africa, Zambia, Zimbabwe, Botswana over the last 21 months. With the exception of a few flights in Africa, we’ve had the majority of our flights and lodging either paid for or heavily discounted.
How? I have no idea how I never came across this concept (i.e., travel hacking) earlier in my life since I’m such a sucker for life hacks, but this happened to coincide around the same time that I started reading about financial independence from sites such as Mad Fientist and Mr. Money Moustache.
The premise of travel hacking is to utilize the credit card rewards system to your advantage. Simply put, you apply for credit cards that offer generous bonus points if you meet their spending limits. For example, if you sign up for a Chase Sapphire Reserve credit card, if you spend $4,000, you get 50,000 bonus points to use towards the purchase of a flight, hotel, or any number of goods and services offered through the Chase Ultimate Reward System.
However, rather than apply for one credit card, the essence of travel hacking is to apply for multiple credit cards to obtain multiple bonus points. Again, for example, Chase offers the following credit cards: the Sapphire, Ink Plus, and Southwest cards, all of which offer excellent bonuses.
Sounds great, but doesn’t your credit score decrease if you have multiple inquiries on your credit report?
Naturally, the first question that comes up with travel hacking is, doesn’t that negatively affect your credit score? While it is true that having multiple inquiries on your credit score can cause it to decrease, don’t forget the positive impact of the credit utilization ratio.
Opening up new lines of credit or having a credit card company do a pull on your credit report constitutes approximately 10% of your entire credit score. Obviously, the more inquiries received on your report, the greater the likelihood your credit score decreases. However, this effect is transient and these inquiries remain on your credit report for 2 years and are subsequently removed.
Don’t believe me? Check out CreditKarma.com. It’s a great (FREE!) tool one can use to view their credit score while also learning more about how credit works.
Back to the concept of credit utilization ratio. Let’s just say you have $1,000 of monthly expenditures and you have one credit card with a limit of $5,000. Let’s also assume that all of your expenditures are paid for using your credit card. Your credit utilization ratio is calculated as follows:
So, you have a credit utilization ratio of 20%.
The credit utilization ratio constitutes approximately 30% of one’s credit score. The smaller the ratio, the better the score. This makes sense because what you’re communicating to creditors is by using less of your credit limit, you’re being responsible with how you’re spending the money made available to you.
Someone who uses more of their credit, like say, $4,000, has a credit utilization ratio of 80%. Even if that person pays off that entire balance on a monthly basis, it still looks worse than someone who has an average monthly balance of $1,000 and who pays that entire balance off on a monthly basis. Why? Because of the way that individual utilizes their credit. The closer you get to your credit limit, the more nervous creditors become irrespective of your ability to pay off the balance on a regular basis, as it’s a cause for concern that you’re not using your credit in a responsible manner.
Let’s say you apply for a new credit card and have been given a limit of $5,000. Using our previous example, you now have a total credit limit of $10,000. Let’s recalculate the credit utilization ratio.
So, now you have a credit utilization ratio of 10%, which is better than the previous ratio of 20%. Clearly, this demonstrates (on paper) that you’re a responsible spender. Just because you have access to more credit doesn’t mean you’re spending more money and your creditors take note of that.
The drive home points:
- Yes, opening up multiple credit cards can cause a transient decrease in your credit score. But remember, this only constitutes 10% of your credit score.
- By increasing your overall credit limit, you’re effectively decreasing your credit utilization ratio (so as long as your monthly expenditures remain fixed), which constitutes 30% of your credit score.
- Do the math: there’s a net positive benefit by opening up additional credit cards.
- Lastly, and it’s one thing I failed to mention. Travel hacking only works if you’re disciplined with your finances. It makes absolutely ZERO sense for you to spend $4,000 to get $1,000 in bonus rewards.
In my next post, I’ll share how my credit score has been affected over the last 20 some odd months since beginning this journey along with which credit cards I’ve obtained in order to reap the benefits of traveling for free (or at the very least, at a heavily discounted rate).