Why Should I Care about My Credit?

It’s a fair question: “If I’m not planning to make a purchase on credit anytime soon, why should I care about my credit at all?” While it’s true that the most commonly known use of credit has to do with getting approved for a loan, there are other situations when credit can have a positive or negative impact (direct or indirect) on our lives.

  1. More employers are checking the credit of potential employeesMany employers check job applicants’ credit prior to making a hiring decision. This may seem unfair and irrelevant to many, but employers reason that since a person’s credit is indicative of their efforts to repay financial obligations, employers may use that information as an additional insight into the job applicant’s overall qualifications for employment. Also, it does seem reasonable to assume (and I’m sure research bears this out) that those with more negative credit “issues” on their reports will have to spend more work time dealing with personal issues. Hence, productivity actually DOES become an issue related to one’s credit. Finally, when the potential employer is in the finance, law enforcement or government sector, credit checks are even more common.
  2. Many landlords check a renter's credit prior to renting out spaceMany landlords, especially property management companies, will check potential renters’ credit scores. Since renting out their property involves the risk that the renter will not pay their obligations on time, a credit check shows which applicants have a history of on-time payments and which do not.
  3. Many auto insurance companies base a portion of their monthly premiums on the vehicle owner’s credit. While morally disputable for some, there is a clear correlation between an individual’s credit score the average size of claims that those with similar credit scores submit.
  4. A utilities account cannot be denied based upon one’s credit, but the company can certainly jack up the security deposit.

So, even if you’re not considering making a major purchase any time soon on credit, it is still a good idea to keep your credit report accurate and as positive as possible.

Todd

Todd Christensen
Director of Education
www.NationalFinancialEducationCenter.org
Facebook: MoneyDay2Day
Twitter: Day2DayMoney

Advertisements

Debt Repayment Options Made Simple

December 20, 2010

One of the most talked about, written about and thought about financial topics in this country is, and has been since its founding, the best way to get out of debt (and then, hopefully, stay out of debt). Yet for all of the tongue wagging, ink wasting, and energy squandering on this endeavor, most American still have an extremely poor, if not completely mistaken, idea of what options they have available to them when they are ready to repay excessive consumer debts.

So, below you’ll find my unofficial “The American Consumer’s Guide to Debt Repayment Options: the Abbreviated (and just about all-you-ever-needed-to-know) Version.” I have listed them in order of their typical impact upon an individual’s credit history and personal finances, from least to greatest, according to  my own opinion:

  1. Pay your debts off on your own
    Minimum Payments Option: Make only the minimum payments requested by your creditors, and it’s quite possible that you’ll need 15 to 25 years to get out of debt – assuming you never use your credit cards again! NOTE: This is universally accepted by financial experts as a poor choice since minimum payments are designed to maximize interest (profits) from your own pockets to those of your creditors.
    Level Payments Option: Never pay less than this month’s minimum payments, even as creditors begin to request a smaller and smaller minimum payment because of a decreasing total balance. NOTE: Realistically, this could have many consumers out of credit card debt in just 5 to 6 years without any direct impact on current household spending levels.
    Extra Payments Option: Use the “Level Payment Option,” but add an extra $25 to $50 (or more) to the payment for the account with the highest interest rate (or, also not a bad choice, the account with the smallest total balance). NOTE: Many such consumers can pay off a $5,000 credit card debt this way in just 3 years!
    Equity Loan Option: Borrow money against the equity in your home or other asset and pay down your credit card debt. NOTE: On paper, this seems like a no brainer, since such loans are often at low interest rates and can have definite tax advantages to them. The problem for many (actually most) who choose this option is that within one or two years, those credit card balances that they paid off with their home equity loan will creep back up to their original amounts, meaning now the consumer will be dealing with the same credit card debts AND be at risk of losing their home because of the additional home equity loan. This is NOT the best option UNLESS the consumer has made a total commitment to budgeting their expenses and reining in any expensive or impulsive lifestyle issues.
  2. Debt Management Program:  A  modified repayment plan available through nonprofit credit counseling agencies (disclaimer: I am employed by one such – see AICCCA.org for a list of nonprofit agencies nationwide). Such programs, known by their acronym of DMPs, target high interest rates and penalty fees. Credit counselors work with creditors to lower the consumer’s interest rates and/or cease any recurring penalty fees. While the debts themselves are not consolidated, the consumer makes just one payment per month to the credit counseling agency, which turns around and disperses the payments to creditors according to accepted repayment proposals. NOTE: Depending upon the consumer’s current credit history, there may be an initial drop in credit score due to the fact that accounts on DMPs must be closed to further usage, which may have a detrimental impact on the consumer’s credit usage ratio. However, FICO has not considered credit counseling as a direct factor in its credit scoring model since 1999, and on-time monthly payments have the greatest impact on credit scores. At the end of the DMP (which cannot last longer than 5 years), creditors should remove any notations on the consumer’s credit report referring to their participation in a DMP, thus leaving no lasting indication of DMP activity. Finally, while consumers can often work directly with a creditor to put into action a DMP for one solitary account, consumers with more than one account will usually find that their creditors are unwilling to provide interest rate concessions unless all of the consumer’s other creditors are also committing to them. That’s were the nonprofit agencies play such an important role.
  3. Consolidation Loan: This option allows consumers to replace multiple smaller debts with one large debt (and, consequently, many monthly payments with just one). NOTE: First, if you’re struggling to repay your debts, you likely have less-than-perfect credit, which means you won’t qualify for a consolidation loan at anything less than an astronomical interest rate. Even consumers who somehow find an affordable consolidation rate are then subject to same temptation as those who use home equity to pay down debts: to recharge those same credit cards back up to unmanageable levels due to poor money management plans and habits.
  4. Borrowing from Retirement: Some retirement plans allow the individual to borrow money or to outright withdraw invested money from their retirement account. There are usually extensive penalty fees associated with some of these options. NOTE: At the very least, the consumer who chooses this option becomes subject to the temptation to recharge their cards back to their original balances, just as the consumer who uses a home equity loan or a consolidation loan.
  5. Debt Settlement: You offer to pay the creditor less than what they say you owe them. Debt settlement can be done directly between the creditor and the consumer, or the consumer may contract with a third-party negotiator (which may even be an attorney) to pursue a settlement. NOTE: Now we’re getting serious. Debt settlement means, by definition, that you have no intention to repay in full the debts that you owe. Such intentions brought to fruition form the basis of a poor credit reputation that is circulated by consumer reporting agencies among potential lenders for the next seven years. Additionally,  fees from third-party negotiators can tally up to 25% or more of the original debt, leaving the consumer still having to pay a total of 80% to 95% or more of the original debt owed.
  6. Personal Bankruptcy: Generally considered the final option where consumer debt is concerned, a chapter 7 or chapter 13 bankruptcy provides legal protections to consumers who are overwhelmed by their debts to such an extent that their creditors are threatening (or actually beginning) to take away all or portions of the consumer’s assets. Assets may include, for example, a home, vehicles, or even income. NOTE: No one enjoys going through bankruptcy. It’s not a pleasant experience. While our own statistics show that there is a fairly significant amount of recidivism among filers (close to 20% have filed before and 3% have filed at least two cases of bankruptcy before their current case), most people end up in bankruptcy due to job loss (about 40%), poor money management (25%) or excessive medical expenses (19%). Going through bankruptcy likely means giving up a portion of control over your own finances and even some of your assets. The consumer’s creditors receive so little of the amount they’re owed that bankruptcy has a solidly negative impact on a consumer’s credit for 7 years and remains on their credit reports for 10 years.

I’m sure there are other, more creative, debt repayment options out there, so I invite you to share those of which you are aware.

Have a fantastic day!

Todd

Todd Christensen
Director of Education
www.NationalFinancialEducationCenter.org
Facebook: MoneyDay2Day
Twitter: Day2DayMoney

Myth or Reality: The Credit Reporting and Scoring Systems Unfairly Hurt Low-income Individuals

December 2, 2010

Relationship of Credit and Income: by National Financial Education Center at Debt Reduction Services IncI’ve frequently heard from participants in my “Credit and the Interest Insomniac” workshops, as we discuss credit reports and scores and they have a real dollar-value impact on household finances, that it is not fair that individuals with less income have to pay higher interest rates. This is especially true when we I show how an individual with poor credit would pay $2,000 to $4,000 more annually for the same house as an individual with excellent credit. Participants assume that the person with poor credit is a low-income individual and the one with excellent credit is a high-income individual.

My response to this is direct and simple: income is not a factor in the credit scoring models used by most lenders. In fact, income is not found anywhere on an individual’s credit report (also known as a credit file, a credit record, or as their credit history). In simplistic terms, the five factors of a credit score are 1) whether or not you at least make your minimum payment on time each month, 2) whether or not you’ve maxed out your credit accounts, 3) how old your credit accounts are, 4) whether or not you’re applying for a lot of new credit accounts, and 5) the variety of credit accounts you have, such as credit cards, mortgage, auto loan, store card, etc.

Nowhere in these factors will you find income. Individuals with low-income, who properly use and repay the limited credit accounts they may qualify for, can build very decent credit. Conversely, high-income individuals who overspend and then abuse their credit cards can end up with a terrible credit score. On an individual basis, income has no direct or indirect impact on credit scores.

Key to Good Credit Is NOT Higher Income: National Financial Education Center at Debt Reduction Services IncThat said, we do have to acknowledge the reality side of this topic: credit bureaus and, consequently, creditors are able to generalize an income range for individuals of a given credit report profile. Essentially, they can determine the likelihood that a group of individuals who meet certain credit report criteria has a certain annual household income. The key words here are “likelihood” and “group.” It’s not a perfect formula, and certain data on a credit report indicate a corresponding income level for the group as a whole, not individually. However, there will certainly be individual variances.

So what can we take from this? Well, we at the National Financial Education Center at Debt Reduction Services Inc continually preach personal responsibility when it comes to personal finances. This is the case again here. In short: responsibly use whatever credit you have, whether it’s a small amount limited by low-income levels or whether it’s nearly unlimited because of being from a high income household. Credit scores depend much more upon what you DO with the credit you have than with HOW MUCH credit you have.

Todd Christensen
Director of Education
www.NationalFinancialEducationCenter.org
Education@NationalFinancialEducationCenter.org
Facebook: MoneyDay2Day
Twitter: Day2DayMoney

Published in: on December 2, 2010 at 10:01 am  Leave a Comment  
Tags: , ,

Reality Check-Credit is Used for More than Just Loans

September 22, 2010

Cut credit cards from your budget

Put foot down on credit cards

The titles of articles such as these are clever, intriguing and seemingly sensible, so why do I have a problem with financial experts (even if he or she is nationally recognized) who preach total abstinence from credit cards across the board?

At a class I taught this past week for individuals going through bankruptcy, I fielded a question that touches upon this very subject. A couple attending the class had been pushed into bankruptcy for several reasons, some of which were somewhat out of their control and others which were within their control. To get a grip on those issues within their control, they had decided to pay $100 to take a financial education course at their church. The creator of these classes preaches life without credit cards.

National Financial Education Center Explains Ups and Downs of Going Cash OnlyAt first glance, the concept seems completely financially responsible: get rid of credit cards, especially if they have been a past temptation to overspend and live above one’s means. So how do you answer someone, like the couple in my class who accepted that principle but are also hoping to purchase a home in the next couple of years, who asks me, “so how can we build our credit without credit cards?”

You see, they want to buy a home in the next few years, and they realize that they’re going to need a decent credit rating in order to qualify for an affordable mortgage. So I ask again, how can they build their credit without credit cards? After all, FICO estimates that about 50,000,000 adults in the US don’t have enough information on their credit reports to generate a credit score.

Here’s my answer, without giving an oversimplified “yes” or “no” answer: you can build your credit rating without credit cards, but you must remember that your credit score is based upon credit-related information on your credit report, and your credit report only contains information relevant to your credit usage and debts. Your credit is NOT based upon your income, your checking or savings account balances, or your debit card usage.

In other words, if you don’t use credit, you won’t have a credit history. I’m sorry to say it, but it’s true. You cannot build credit without using credit in some form.

Here are the types of credit that exist:

  1. National Financial Education Center Explains Ups and Downs of Going Cash OnlyRevolving Credit: Accounts like credit cards that allow you to make charges, pay some off each month, make more charges, etc. These are the most influential types of credit accounts on your credit report.
  2. Installment Credit: Accounts with fixed pay-off dates and generally fixed monthly payments, such as car loans and student loans.
  3. Mortgage Credit: Accounts that look like installment loans but that are tied to real estate.
  4. Home Equity Credit: Accounts that function like revolving lines of credit but  are tied to real estate, like mortgage credit.
  5. Service Credit: Accounts for services such as electricity, gas, or other utilities where weNational Financial Education Center Explains Ups and Downs of Going Cash Onlyreceive the service and are then billed for our usage. Note: phone accounts that are paid in advance are not considered service credit accounts. Also, most service credit accounts are not automatically reported to the credit bureaus that keep track of your credit history.

That’s it! If you don’t have any of these accounts listed on your credit report, you have “no file.” That means that FICO can’t find enough information to generate a standard credit score for you.

You have two options:

  1. Build your credit report wisely, starting with retail (think department stores), gas, or tire store cards or lines of credit that are generally easier to qualify for. However, using credit wisely means you pay off any balance IN FULL EVERY MONTH. After a period of time (perhaps 12 months or so), you might consider applying for a major credit card through your bank or credit union. If you’re tempted to use the card inappropriately (not paying it off in full every month), then cut it up.
  2. Ask your potential lender if they subscribe to the FICO Expanded Score. FICO is able to create a “credit score” on a large percentage of those with no traditional FICO score by accessing information on bank accounts, purchase payment plans, and property and public records. However, you will likely find it much more difficult (if not impossible) to qualify for a mortgage loan through most lenders based solely upon the Expanded FICO.

In the end, credit is about personal financial responsibility. Living without credit may be the financially responsible thing to do. However, it leaves no record or proof for potential lenders to convince them that you are likely to repay their loan to you.

And I haven’t even mentioned yet (since each would be a topic for another day) that your credit report and score are used for various reasons other than just qualifying for a loan. Here are some of the more prominent among those who are using your credit score to make decisions:

  • Many auto, home and life insurance companies (your score affects your premium)
  • Property management companies and many landlords
  • More and more employers (during the hiring process)
  • Utility companies (determining your security deposit)
  • Cell phone companies

So while I am, in theory, a fan of the “credit card-less” household, I don’t see it as practical for many if not most households. Since it takes two or three years of responsible credit usage to build a strong credit history, you may particularly want to focus on building your credit if you’re looking at buying a home, applying for a job, getting a cell phone account, or renting a home or apartment any time soon.

Otherwise, by all means, go cash only!

I may be opening up a can a worms, but I’d be happy to hear other opinions on this.

Todd Christensen
Director of Education
www.NationalFinancialEducationCenter.org
Facebook: MoneyDay2Day
Twitter: Day2DayMoney

Yahoo Reports High Risk FICO Scores on the Rise

Increasing Account Delinquencies / Foreclosures Drive Credit Scores Down

A Yahoo report of July 12, 2010 indicates that a growing number of US consumers have the ranks of high risk borrowers (FICO score of 599 or less). Following increasing foreclosures and delinquent debts due to the high unemployment and underemployment rates of the down economy, this segment of credit scores has grown from the typical 15% of consumers to over 25% as of April 2010.

See http://yhoo.it/a89YNn for the Yahoo report.

Watch a TV news video of CBS 2 Boise interview regarding the report: http://bit.ly/agVBkQ.

Todd Christensen
Director of Education
www.NationalFinancialEducationCenter.org
Education@NationalFinancialEducationCenter.org
Facebook: MoneyDay2Day
Twitter: Day2DayMoney

Published in: on July 15, 2010 at 10:04 am  Leave a Comment