The Danger of Playing the Credit Card Rewards Game

One of the perks of having high credit scores is you’ll get lower interest rates on things like car loans, mortgages and credit cards. And in the case of credit cards, many issuers who are after your business offer generous “sign-up bonuses,” leading some people to chase the big rewards. In some cases, they’ll apply for a card that has an annual fee that is waived the first year, cancel the card and then go for a competitor’s big sign-up bonus. The rewards can be tempting.

But most of us know that rewards often come with an unwelcome companion: risk. Is it risky to try to claim these bonus rewards? In general, you have to have very good credit in the first place to qualify for the cards that offer the big rewards. So is there a risk in taking the incentives card issuers are offering?

There can be, says credit card expert Barry Paperno, who cautions, “It should also be understood that the scoring risk from churning is more likely to be a lower score — all other things being equal — than you would otherwise have without the continual flow of new and closed accounts on your credit reports.”

Before you apply, it’s a good idea to find out if you can afford to lose a few points on your credit scores. If your score isn’t in “very good” or better territory, churning is almost certainly not a good idea for you. (You can check and monitor your scores for free on Credit.com, as well as see a strategy for maintaining or improving your scores. It’s a good idea to know where you stand so that when you apply for credit, you’re applying for a type that’s the best fit for you.)

Paperno is not saying that churning is a bad idea, but he is saying that it’s not for everybody. If you’re considering it, it’s just as important to take a hard a look in the mirror as it is to understand exactly what you have to do to qualify for those enticing incentives. Because the only people who should even attempt such a strategy are those “who can not only make their payments on time, but also pay their balances off each month without incurring finance charges, since, after all, the purpose of churning is to save money,” he said.

If that’s you, and your credit score is high enough so that a bit of a drop will still leave your credit at “very good” or better and you don’t plan to apply for any other big loans in the near future, go ahead. If that’s not you, then chasing the sign-up bonuses could end up costing you in the long term — rewards cards tend to charge higher interest, and if you forget to cancel, you may pay a hefty annual fee that could easily top $100 for premier cards.

As if losing money on the deal weren’t bad enough, chasing bonuses could potentially hurt your credit in two scoring categories: length of credit history and new accounts (history of searching for credit).

Length of credit history makes up about 15% of your credit score, so a strong payment history (35% of your score) and low credit utilization (30%) can help counter the shorter credit history that will result from new cards.

Your history of searching for credit makes up about 10% of your score. Just opening a new account (or applying for one) causes a small, temporary drop in your credit scores, Paperno said, “It is also helpful to keep in mind that while ‘good’ scores are indeed possible for a credit report containing multiple recently opened accounts, to get a ‘very good’ score (750+) you should not have more than an occasional recently opened account.”

Some people are able to collect big rewards and maintain good credit while churning — but it’s important to understand the rules and to be aware of your own habits before you get in the game.