Travel Tips

How a “Churn and Burn” Credit Card Strategy Impacts Your Credit

For those uninitiated, a churn and burn credit card strategy is one in which consumers apply for a credit card to collect a lucrative sign-on bonus, then close the card after those points or funds have been collected. Typically, applicants get rid of the card before the cardmember anniversary to avoid potential annual fees.

There are quite a few aggressive burn and churn enthusiasts out there, applying for many cards in a calendar year. I suspect that many, myself included, are more modest churners, limiting applications to a couple a year at most.

With all this opening and closing of accounts, there is no question that it has an impact on your credit score and, subsequently, future borrowing. How much it will affect you specifically is based on your habits and current account statuses. It helps to know how scores are calculated to examine the possibilities.

Your FICO score is generated based on the following categorical breakdowns:

  • Payment History: 35%
  • Amounts Owed: 30%
  • Length of Credit History: 15%
  • New Credit: 10%
  • Credit Mix: 10%

A VantageScore is calculated using similar metrics, but with a slightly different breakdown:

  • Extremely Influential – Payment History
  • Highly Influential- Age and type of credit, % of credit limit used
  • Moderately Influential – Total balances/debt
  • Less Influential – Recent inquiries, available credit

Your score may vary slightly based on the model you pull. You shouldn’t, however, see a large disparity between the scores. If that is the case, it would be smart to check your credit reports to be sure there are no oddities lurking.

Obviously, based on the information above, it’s always smart to keep your payment history clean and your utilization or amounts owed low. This is one major risk when implementing a churn and burn strategy. We have to be sure we are not extending our monthly spend to meet the card requirements. Most cards require a spending threshold to be met within a certain time period. Only apply for a card if you know that your spending habits are conducive to the requirement. This ensures that you would be able to keep the utilization low, ideally at 0%, because you have the funds to pay off the balance immediately.

This utilization rate is important to know when you think of closing an account. Say you have two cards currently. One, card A, is a standard card you’ve always had and plan on keeping long term. The other, card B, is your churn and burn card. We’ll pretend that both have a limit of $10K, making your combined credit limit $20K. If you have a balance on card A of $5K, and card B $0, your utilization ratio would be $5K/$20K, or 20%. Banks and lenders prefer consumers to be under 30%. I prefer and suggest 0%.

Now, since you don’t have a balance on card B and it is your burn card, you decide to close the card. Essentially, when you close that account, your credit limit for that particular card is lost with it. If you still have the remaining $5K balance on card A, that brings your ratio to $5K/$10K, or 50%. The account closure has greatly increased your utilization ratio and can have a profound impact on your score.

Of course, this assumes the consumer carries a balance. If you don’t, an account closure, in and of itself, will have no impact on your score.

The area in which you will for sure impact your credit score, albeit temporarily, is in the “new credit” or “recent inquiries” categories. Every new application acts as a hard inquiry and will lower your credit score. By how much depends on the individual, but given that this category is one of the least influential, the negative dip is transitory and your score should rebound quickly with continued good habits.

Another consideration relates to the average length of your revolving accounts, categorized as “length of credit history” with FICO. Closing an account in good standing with a long history could have a deleterious effect on your score. Generally speaking, it’s best to close newer accounts to limit the ramifications, which is a common strategy for churn and burners. Accounting for roughly 15% of your score, it’s certainly something, but having a good credit mix with other long-standing accounts will help combat any drop in your score.

Many people have used the churn and burn method with great success, allowing themselves to save hundreds, if not, thousands of dollars on travel expenses. Beyond travel considerations, knowing how your credit score is calculated is empowering in that it helps make all of your credit-related decisions easier.

As I said, I am a modest churn and burner. I’ve been employing the strategy for a number of years. My credit score has never been higher. This is due to keeping a low utilization rate and being diligent about making all payments on time. Any drop in my score from a new inquiry is short lived because of this.

All this being said, it’s not for everyone. I always suggest having solid budgeting and money management skills before dedicating a bulk of your spending to credit card transactions. For every person that has reaped the rewards from generous credit card offers, there are more that have been stung. These companies are making money somehow.