Archive for August, 2008

The title alone might surprise some people who mistakenly believe that a person’s credit score and also their credit reports are something issued by the government like birth certificates and Social Security cards.
It’s easy to understand the mistake — your credit report and credit score have almost as much impact on the lives of an American citizen as a government-issued document: Your credit report may make or break you in the job world, help or hamper you in your dream of attaining a home or auto.

So why and for who was credit scoring first developed? Fair Isaac was started in 1956 as a way for businesses to make better credit-granting decisions and billing. In 1970, the company developed its first general credit card scoring system. In 1975, it introduced its first behavior scoring system to predict credit risk related to existing customers, and in 1981, Fair Isaac successfully marketed its scoring system to the existing credit bureaus: Equifax, TransUnion and TRW (now Experian).

When a consumer’s credit history became available through modems and then later the Internet, mortgage companies were able to pull a customer’s credit score, and it was sold to the banking industry as a way to save time in making credit decisions; indeed, a person’s credit score became the first line of defense for underwriters. In most cases, the data which produces the score, i.e., the credit report, is no longer reviewed.

Which would be better — government bureaucracy with all its red tape to handle your credit or private companies? The Fair Credit Reporting Act, which monitors the activities of credit reports and the scoring system, was implemented to protect consumer privacy from the lax approach of one credit bureau in particular. In the 1960s and early 1970s, Equifax was attacked by Columbia University Professor Alan Westin, who laid into the bureau for its cavalier attitude toward the accuracy of its information on consumers, and for giving out that information to practically anyone who asked for it.*

Currently, the specifics of what goes into the available scoring models is “classified” information — would the government be more transparent if it had been running the credit game? I would hazard a guess of “yes,” as this type of regulation would not be considered military secrets or national security. The developers of the credit scoring system argue that “transparency” would allow consumers to manipulate the scoring system and “render it useless.” I’m not sure I agree — a late paying record or bankruptcy cannot be “manipulated.”

I see far too many abuses of consumer data by the bureaus in the name of increasing profits by cutting corners; computer-automated error disputes, lack of staffing and minimal review (if any) of consumer-provided documentation. It’s common knowledge that fully 60%+ of consumer credit reports contain errors — if the government ran things, disputes might take weeks to resolve, but most likely a human being would be involved.

What’s your opinion on the effectiveness of our current credit reporting system?

Footnote

* Wired Magazine: http://www.wired.com/wired/archive/3.09/equifax.html

The title question may seem ridiculous on the surface — we’re all seeing prices in our everyday lives go up. But is one of the factors in the current rise in prices our own fear and uncertainty? The two biggest price increases in the news these days are food and gas. Are food producers and fuel companies taking advantage of this headline-grabbing information and increasing prices because in part because we expect things to cost more?

To answer this question, let’s look at some real data on exactly how much prices are going up. The Consumer Price Index (the U.S. Consumer Price Index is a time series measure of the price level of consumer goods and services, or basically — how far does your dollar go in the current economic environment) shows:

3-month comparison:

• Energy costs: 28.2% increase in the compound annual rate for the 3 months ended May 2008
• Food costs: 6.2% increase in the compound annual rate for the 3 months ended May 2008

1-year comparison:

• Energy costs: 17.4% increase in the compound annual rate for the 12 months ended May 2008
• Food costs: 5.1% increase in the compound annual rate for the 12 months ended May 2008

So for food, 5% over last year — not so bad, but energy, 17.4 % — ouch! Now let’s take a 10-year look:

• CPI food in May 1998: 160.3
• CPI Food in May 2008: 211.918

• CPI Fuel and Utilities May 1998 129.3
• CPI Fuel and Utilities May 2008 222.094

Over 10 years, food is up 25%, fuel 75%, again — ouch! However, the spike in fuel costs has happened all in the last year, and, many people feel, is due in large part to speculation. Will this trend continue? Oil will probably not go back down to $50/barrel, but the recent run-up in prices looks suspiciously like a bubble to me.

Panic in the stock market has reared its ugly head several times in the past — 1928, 1987, 2001 — and was always preceded by what Fed Chairman Greenspan famously labeled “irrational exuberance” in the stock markets. The current climate was definitely the irrationality of the real estate market. I submit that as fast as the real estate market zoomed inexplicably upwards, a frenzied “the sky is falling” climate can drive prices in an equally irrational direction.

You may be thinking that closing credit cards is a great idea: It will reduce the temptation of using them and “simplify” your life. And it will make you a lower credit risk if you have fewer cards, right? Well, before you take the plunge and cancel credit accounts you’ve had for a while, think twice — your credit score is what will take the plunge!

One of the most common misconceptions about personal credit is that closing credit cards, particularly accounts you don’t use, is a good idea. If you close an “established” account, especially if it has been a satisfactory (always paid) account for over two years, it will lower your credit scores. Why does this happen? The reason is that 15% of your credit score is computed from the “length of credit history,” which is the time since accounts were opened and the time since account activity. Hence, people with credit accounts in good standing for a long time typically have the highest credit scores.

If you close a seasoned credit account, you lose the ranking and value this account had in the calculation of your credit score. How much could it go down? Well, that depends. However, because the FICO credit score range is 550 points (300-850), the most it could reduce your score should be 82 points (15% of 550). That is a huge hit to take and would almost certainly bring your credit rating down so far that you would pay higher interest rates on any new accounts you open. If your credit issuer applies “universal default,” you could even find yourself paying a higher interest rate on existing accounts that are in good standing!

The only valid reason to close an unused account is risk: Either you’re worried about someone stealing the numbers and committing fraud, or you fear you’ll overspend if you have the card available. Well, your fraud protections on credit cards are actually quite good, as long as you check your statement and report acts of fraud quickly. As far as overspending goes, that’s a personal choice — just be aware of the negative impact of closing accounts.

The bottom line is, you want to avoid closing out older credit card accounts, since your credit score will go down.

Like most offers that sound too good to be true, be careful about credit card balance-transfer offers. You might end up paying a bunch of money in fees or even lower your credit score.

Millions of these pre-approved credit card offers are mailed out every month. Often they offer 0% interest on all transferred balances for a time period. These balance-transfer offers allow you to use available credit from one card to pay off balances due on one or more other credit cards. Usually the special low rates expire after a certain time period. Moving balances that are being charged a high interest rate to a credit card with a much lower rate seems to make perfect sense.

Credit Balance Transfers and Credit Score

But transferring can reduce your credit score, which could cost you far more in other ways than it will save you on interest charges. Your credit score could drop because:

• If you a close a long-standing account (the one you transfer from), especially if it has been in good standing for over two years, your score will fall drastically.
• When opening the new card, or even just transferring the balance to an existing card, a credit inquiry will likely occur, dropping your score around five points.
• Adding another new credit account may lower your credit score because of your increased debt exposure (it may help in the long term, however).

Another issue to be concerned about is hidden fees. Depending on your past history and credit score, most balance-transfer deals require you to pay a fee. This could be a flat rate or a percentage of the amount borrowed. You also need to understand what happens to your rate when the limited-time offer expires and you still carry a balance. You might find yourself with a very high interest rate again.

If you pay close attention to the fine print and pay off the balance transfer amount during the promotional interest rate period, you can have a good experience and cut your monthly expenses by reducing your interest payments. And remember to keep your old credit card account open, or your credit score may drop big-time.

Do you have “clean” credit but wonder if your credit score could be higher? Should you take out loans to help your credit score, and if so, how many?

You’ve probably heard how important it is to build a strong credit history. Unfortunately, there’s no way to get a “good” credit score just by paying cash. You need long-standing, satisfactory credit accounts on your credit report in order to have a hope of improving your credit score.

Why are your credit history and score so important? Your personal credit history is a measure of your financial trustworthiness. Good credit means it’ll be easier for you to get loans, credit cards, home mortgages and low interest rates. And low interest rates usually results in lower monthly payments — saving you lots of cash. So, clearly, having solid credit is a big deal, and having poor credit can be a costly problem.

Most banks and other credit grantors use a credit score to predict whether you’re likely to repay a loan and make timely payments. This means they take your credit application and pull your credit report to learn things about you, like your annual income, overall debt, payment history, and the number and types of credit accounts.

Many people just have a chicken-or-egg problem: They have little or no credit history, but it’s difficult to get credit in order to build that history! Establishing a good credit history usually isn’t as difficult as it seems. Consider these options:

• Apply for a store or gas credit cards, since these retailers are usually more willing to issue credit to someone with no history. If you pay these bills on time, then major credit card companies will probably issue you a card down the road.
• Look for “secured” credit cards. Essentially, secured cards require you to put up cash that you borrow again. These are pretty easy to get, if you have the money, and will help you build a positive credit account.
• Find a co-signer. You can ask other people who have an established credit history to co-sign on an account. By co-signing, though, the other person agrees to pay back the loan if you fail to.

How many loans or credit cards should you take out to help your credit score? That’s a question that depends on a lot of factors, but most people should avoid opening more than a few accounts in a short period (within six months). Over time, you will want three or more long-term credit accounts in good standing on your credit report in order to have a chance at a good score.

Once you start to build your credit history, be patient, as it will take many months, even years, to get into the better credit brackets. Make sure you pay your bills on time, and don’t open too many accounts at once.

You just might be able to get a lower interest rate on your credit card by — believe it or not — calling and asking for it! Especially if you’re a loyal customer or have good credit.

It sounds too easy, but think about it: The interest rate on your credit card is, essentially, just an agreement between you and the issuer. That means it’s open to negotiation. So although the issuer has no legal obligation to lower it, you have no legal obligation to remain a customer either!

If you have a good credit score or your score has improved since you opened the account, you have a great shot at a lower annual percentage rate (APR). Long-standing customers and those who haven’t had recent unpaid bills (at least six months of on-time payments) also have a better chance.

Another point to consider: Your credit card company can borrow money at the federal fund rate, which is usually in low-single-digit percentage points. However, cardholders like you are borrowing from the issuer (if you carry a balance) at far higher rates — 16%, 18%, sometimes well over 20%. So there’s probably room for a compromise.

Also working in your favor is that there’s plenty of competition in the credit card market. The cost to acquire a new customer may be as high as $100 or $200, so it makes sense to keep a card customer in the fold.

The bottom line is your request for a lower APR has a pretty good chance of being accepted. And don’t be afraid to ask for a very steep drop. Depending on your current rate, start negotiations at a 5% or even 10% reduction.

What should you say when you call? I recommend you be polite and non-threatening, but firm. “Hi, I’ve been a customer for a while, I pay my bills and have good credit. I’ve gotten many offers from other credit card companies with lower interest rates. So I want a lower APR on my card with you, or I may consider switching. Can you help?”

If you pay off your balances every month, then you may think you don’t need a lower interest rate. That’s a fair point, but what happens if, just by accident, your monthly payment is received late? Then you’d pay a higher late fee than you would otherwise.

If you do order your credit score, make sure you get your three FICO scores. And if you do switch to a lower rate, don’t close a long-standing credit card account — your credit score will drop substantially.

You may have heard that credit card companies will “ding” your credit report if you pay off your balances, harming your credit rating. This is simply untrue. One of the best ways to improve your credit score over time is to keep your credit card balances low (this goes for other “revolving” credit accounts too).

What is Credit Utilization Ratio?

The reason for this is that 30% of your FICO credit score is calculated using the “amounts owed.” This makes it the second most important criteria after payment history. So keeping low balances helps because the credit score formulas use a “credit utilization ratio,” which is the current unpaid balance on your accounts divided by the credit limits on those accounts. In other words, credit utilization is simply how much of your credit limit you’re using. The higher your credit utilization, the lower your credit score. The opposite is also true — reducing your credit utilization ratio will eventually increase your credit score (everything else being equal).

Obviously, there are two ways to reduce your credit utilization: by paying off your balances or by increasing your credit limit (if you can do both, you’re even better off). Don’t be fooled into thinking that closing accounts will help; canceling established credit cards that are in good standing will hurt your credit score because it will decrease your overall credit limit.

Another very good — and obvious — reason to pay off your balances is that it’s the best way to live within your means and avoid paying high interest rates on balances that just eat up more of your hard-earned cash.

So, the lesson here is to pay off your credit card balances every month. It should help your credit score and keep more money in your pocket. And higher credit scores should result in lower interest rates for credit.

Are you someone who does not believe in using credit cards? You’ve probably heard that it’s important to build a strong credit history. Is this true, or can you get a good credit score just by paying cash, building up a nice savings account and having no negative credit history?

Unfortunately, if you’ve paid cash your entire life or have no credit history, you may not have "good credit" in the eyes of lenders or banks.

Now, whether that matters depends on your life goals. But you need to have a substantial credit history if you ever want to buy a house or get a car loan. And even if you can get credit, a poor credit history will cost you thousands of dollars because you’ll be saddled with higher interest rates on your loans.

Even if you’re very responsible with your money, you could be surprised to discover that there’s little reward when it comes time to buy a home or lease a car. The reason is that lenders like banks make credit decisions — and determine your interest rate — after assessing your risk. They do so by examining your credit report or credit score. Your three-digit credit score is used to determine your credit worthiness for nearly all applications for credit, insurance, rental units, and even utility companies. Credit scores were designed to predict the chances that you won’t pay your bills in the future. Scores are based on payment history, amounts owed, length of credit history, mix of credit, and new credit.

So if you always pay cash and have no — or very few recent —credit accounts, you may have a lower credit rating than you imagine — even if you have a very high income and have never been late paying a bill. You’d think that paying cash for everything shows that you’re financially responsible, but the credit risk system doesn’t work that way.

Building Your Credit History

The good news? There are a number of legitimate ways to build up a solid credit history over time (none of them involve paying someone to "boost" your credit score or other such trickery). They include obtaining credit cards or store charge cards (there are "secured" cards for those who don’t qualify), getting listed as an authorized user on someone else’s card, getting a parent or guardian to co-sign, and getting utility service. There are also credit unions or banks that have programs to help people establish their credit.

When you’ve always paid cash, the best strategy to prepare for your long-term financial needs involves three basic steps: start building your credit history long before you need it; be patient; and, of course, pay your bills on time.

You’ve likely seen the offers for credit monitoring services that promise to monitor your credit file and notify you within hours of any changes. Typically, a monitoring service will notify you of changes to your credit file that occur as a result of new inquiries, late payments, new accounts opened in your name, address changes, new employers, bankruptcies and other public records and more.

So is credit monitoring worth the money? Well, that’s a personal choice that depends largely on your specific situation and if you have a spare $100-$150 per year that you want to spend on monitoring services. Here’s some information that can help you decide for yourself.

Credit monitoring benefits

• Alerts and notification. Credit monitoring does indeed offer you value in that you will be alerted, albeit not necessarily as fast as they would like you to believe, in changes in your credit report. If an identity crook is opening new accounts in your name, changing your address, or otherwise causing changes in your credit file, then you will get notified of those changes. And the sooner you know of potentially fraudulent activity, the sooner you can do something about it to minimize the financial impact to you.
• Credit management. In addition to alerting you for fraudulent activity, credit monitoring can actually assist you in managing your credit.

Credit monitoring limitations

Understanding the limitations of credit monitoring is a critical step toward deciding if it’s right for you. Among its limitations, credit monitoring:

• Doesn’t detect all types of fraud. There are plenty of fraudulent acts that can occur that don’t cause changes to your credit report and therefore aren’t included in credit monitoring alerts. If an identity crook compromises your existing accounts, steals and uses your Social Security number with another name, or opens an account that doesn’t require a credit check, credit monitoring won’t help you.
• Is expensive. For some, credit monitoring is pricey at $100-$160 per year for services that, for the most part, you can do yourself. Some folks would rather spend that money on something else.
• Isn’t as real-time as advertised. You’ll notice that many services boast about daily monitoring. The reality, however, is a bit different, especially when you realize that creditors often delay their reporting to the credit bureaus.
• Isn’t your only option. There are alternatives to monitoring, such as identity-monitoring services that might cost less. Plus, you can do a fair job of monitoring your credit reports yourself for free. While not as “real time” as a monitoring service, you can get a free report from each of the bureaus and examine these reports for changes several times per year. Due to the cost of credit monitoring, this can be an appropriate alternative for some.

In the end, whether or not credit monitoring is worth the money is a decision that you have to make. It provides a good amount of value, but it might be cost-prohibitive for some people, and they might choose an alternative.

So you found out that you’ve become a victim of identity theft. Perhaps you applied for new credit and suddenly discovered some bogus accounts or some derogatory information on your credit report. Now what do you do?

You’re likely to find that talking to the lender is futile. They simply cannot take what you are saying at face value; as unfair as it is, you’re going to need to prove that you have in fact become an identity theft victim and dispute each inaccurate or fraudulent entry in your credit file. The following can help you work through the problem.

• Identify inaccuracies on your credit report. Continue to examine your credit files closely. Obtain a copy of your credit report from all three bureaus, and review them to identify any inaccurate, fraudulent, or otherwise suspicious information.
• File a police report. If you’re the victim of identity theft, you need to file a police report. The report will be instrumental in helping you clean up your credit file and getting creditors to understand that you’re an identity theft victim.
• Choose the reports to dispute. Not all bureaus have the same information, so you may not be disputing a particular activity with all three bureaus. Dispute the inaccuracy with the specific bureau that issued the report. If more than one bureau is reporting the inaccurate or fraudulent information, you’ll need to dispute it at each one.
• Prepare the dispute letter. A dispute letter should include the date, your name and address, and clearly identify the specific item that you are disputing. Lay out the facts, and explain why you’re disputing the item. You should attach a copy of the credit report with the disputed item circled or highlighted, along with any and all documentation that supports your position. Specifically state in the letter that you’re requesting that the item be deleted/corrected. There are a variety of sample dispute letters on the credit bureau websites that you can use as a reference.
• Send the dispute letter. The dispute letter needs to be sent to each bureau that issued inaccurate information. You need to send the letter via certified mail, return receipt requested, so you can document that the credit bureau received your letter. Keep copies of your dispute letter, all attachments, and any future correspondence that you send or receive.
• Monitor the progress. Cleaning up fraudulent activity can take a while. Once you’ve sent the letter to the credit bureau(s), you need to make sure that they respond in a timely fashion. Sometimes you may be working on several issues with each of the credit bureaus. Make sure they received the report through certified mail, and allow them approximately 30 days to investigate the item. If you haven’t heard from them after 30 days, contact them again, and provide any needed supporting documentation to prove your case.

Cleaning up the work of an identity crook isn’t easy. It can be time-consuming and frustrating, but if you follow a process, your perseverance can pay off.