Thursday, October 18, 2007

Impact of CC Arbitrage on Credit Score

Following my post on Credit Card Arbitrage two days ago, Esme (from Brown Eyed Girl and Money), asked a question:
"Do you know if this balance transfer will have a negative impact on credit rating?"
Since credit scores are a complex subject, I thought I'd write a seperate post to answer that question. I will only discuss the impact of using a balance transfer for credit card arbitrage. For more general information on credit scores, The Financial Blogger has a nice series of articles.

The credit score takes into account a number of things when looking at credit cards:
  1. How many credit cards do you have? Obviously, opening a new credit card account increases this. This is not necessarily a bad thing, if you don't have many of them. This raised my number of cards from 3 to 4, which should not be negative considering my credit history.
  2. What is the average age of your accounts? Opening a new account, however, will "dilute" your existing credit card accounts, so the impact will be negative. I've held two of my credit cards for a long time, while the third was recent. So I've effectively cut my average by half. I'm not sure how this will impact my score.
  3. What is the total credit limit accross all account? This is another area where opening a new account has an impact. However, this is not necessarily negative. Before opening my new card, I had kept my total limit quite low (about $11,000), so the $11,000 limit they granted me of this card raised my total to $22,000. I think this is still reasonable, if a bit high for my personal tastes.
  4. What percentage of your total limit are you using? That is the area where you can take the biggest hit on your credit score when using a balance transfer for arbitrage. If you open a new card and max it out right away, you will increase your utilization ratio substancially. Since this is an experiment, I kept the amount drawn from the new card low, at $5,000 out of a limit of $11,000 -- which is about 45% of the credit limit. I previously had a 50% utilization ratio, so it basically remained the same.

Now, I still expect to take a hit on my credit score. But since the next time I need to negociate a loan is about 18 months away (when I renew my mortgage), it will have time to recover.

1 comment:

Esme said...

Thanks for answering my question :)