Saturday, December 29, 2012

FICO - Fixing Your Credit Score and Maintaining Good Credit

Tips on How to Fix a Credit Score & Maintain Good Credit

1. Payment History Tips

Contributing 35% to your score calculation, this category has the greatest effect on improving your score, but past problems like missed or late payments are not easily fixed.
  • Pay your bills on time.
    Delinquent payments, even if only a few days late, and collections can have a major negative impact on your FICO score.
  • If you have missed payments, get current and stay current.
    The longer you pay your bills on time after being late, the more your FICO score should increase.  Older credit problems count for less, so poor credit performance won't haunt you forever.  The impact of past credit problems on your FICO score fades as time passes and as recent good payment patterns show up on your credit report.  And good FICO scores weigh any credit problems against the positive information that says you're managing your credit well.
  • Be aware that paying off a collection account will not remove it from your credit report.
    It will stay on your report for seven years.
  • If you are having trouble making ends meet, contact your creditors or see a legitimate credit counselor.
    This won't rebuild your credit score immediately, but if you can begin to manage your credit and pay on time, your score should increase over time.  And seeking assistance from a credit counseling service will not hurt your FICO score.

2. Amounts Owed Tips

This category contributes 30% to your score's calculation and can be easier to clean up than payment history, but that requires financial discipline and understanding the tips below.
  • Keep balances low on credit cards and other "revolving credit".
    High outstanding debt can affect a credit score.
  • Pay off debt rather than moving it around.
    The most effective way to improve your credit score in this area is by paying down your revolving (credit cards) debt.  In fact, owing the same amount but having fewer open accounts may lower your score.
  • Don't close unused credit cards as a short-term strategy to raise your score.
  • Don't open a number of new credit cards that you don't need, just to increase your available credit.
    This approach could backfire and actually lower your credit score.

3. Length of Credit History Tips

  • If you have been managing credit for a short time, don't open a lot of new accounts too rapidly.
    New accounts will lower your average account age, which will have a larger effect on your score if you don't have a lot of other credit information.  Also, rapid account buildup can look risky if you are a new credit user.

4. New Credit Tips

  • Do your rate shopping for a given loan within a focused period of time.
    FICO scores distinguish between a search for a single loan and a search for many new credit lines, in part by the length of time over which inquiries occur.
  • Re-establish your credit history if you have had problems.
    Opening new accounts responsibly and paying them off on time will raise your credit score in the long term.
  • Note that it's OK to request and check your own credit report.
    This won't affect your score, as long as you order your credit report directly from the credit reporting agency or through an organization authorized to provide credit reports to consumers.

5. Types of Credit Use Tips

  • Apply for and open new credit accounts only as needed.
    Don't open accounts just to have a better credit mix – it probably won't raise your credit score.
  • Have credit cards – but manage them responsibly.
    In general, having credit cards and installment loans (and paying timely payments) will rebuild your credit score. Someone with no credit cards, for example, tends to be higher risk than someone who has managed credit cards responsibly.
  • Note that closing an account doesn't make it go away.
    A closed account will still show up on your credit report, and may be considered by the score.
To summarize, "fixing" a credit score is more about fixing errors in your credit history (if they exist) and then following the guidelines above to maintain consistent, good credit history.  Raising your score after a poor mark on your report or building credit for the first time will take patience and discipline.  Log into myFICO for more information.

FICO - the U.S. credit score system

FICO = Fair Isaac Corporation

What is your FICO score?

What do you mean "you don't know?"  Every U.S. tax person has a FICO score.  Whether you’re buying a home, a car or applying for a credit card – lenders want to know the risk they’re taking by lending your money.  FICO scores are the credit scores that most lenders use to determine your credit risk.  Your FICO credit scores (you have 1 score from each of the 3 major credit bureaus) can affect how much money a lender will lend you and at what terms (interest rate).  

So, taking steps to improve your FICO scores can often help you qualify for better rates from lenders – which can save you money!

FICO scores range from 300-850 and higher is better. 

You can also see that your FICO score looks at several major categories as shown by the key ingredients in the pie chart above.  For more information about these general categories, see the What's in your score page.
Your FICO score is calculated using the information in your credit reports. These reports contain all of the information that each credit bureau has on file about you. This sample credit report shows a few examples of the types of information that the credit bureaus collect, such as your credit accounts, how many times lenders have requested information about your credit (Inquiries), and how many times lenders have turned your account over to a collection agency (Collections).

3 Important Things You Can Do Right Now

  1. Check Your Credit Report – Credit score repair begins with your credit report. If you haven't already, request a free copy of your credit report and check it for errors.  Your credit report contains the data used to calculate your score and it may contain errors.  In particular, check to make sure that there are no late payments incorrectly listed for any of your accounts and that the amounts owed for each of your open accounts is correct.  If you find errors on any of your reports, dispute them with the credit bureau and reporting agency.
  2. Setup Payment Reminders – Making your credit payments on time is one of the biggest contributing factors to your credit score.  Some banks offer payment reminders through their online banking portals that can send you an email or text message reminding you when a payment is due.  You could also consider enrolling in automatic payments through your credit card and loan providers to have payments automatically debited from your bank account, but this only makes the minimum payment on your credit cards and does not help instill a sense of money management.
  3. Reduce the Amount of Debt You Owe – This is easier said than done, but reducing the amount that you owe is going to be a far more satisfying achievement than improving your credit score.  The first thing you need to do is stop using your credit cards.  Use your credit report to make a list of all of your accounts and then go online or check recent statements to determine how much you owe on each account and what interest rate they are charging you.  Come up with a payment plan that puts most of your available budget for debt payments towards the highest interest cards first, while maintaining minimum payments on your other accounts.
Get educated, financially literate and stay informed about your credit score.  You FICO score is relevant for almost anything financial, from mortgages, to car loans, to mobile telephone accounts and more.  Know your score, and protect your information.  

For a low monthly fee myFICO will track and report changes to your credit profile automatically, including updating you on your score every few months, informing you of any credit applications (that you made, or that someone may have made using your information), changes to your address/telephone information detected, and more.  Log onto their website for more information.

Disclosure: I am a myFICO client, enrolled in their monthly tracking program (cost: about $5/month)

Thursday, December 27, 2012

Should you invest in stocks or bonds?

Are you investing your savings in stocks, or bonds?

According to a Dec 27 CNN Money article, investors yanked $150 billion from the stocks, mutual funds and ETFs for the third year in a row.  Where did the savings and/or investments go, or end up?

The article mentions that 'Baby Boomers' - who represent the largest group among retail investors - had shifted their investments out of stocks and into bonds much earlier than usual, as they head into retirement.  It also suggests that this generation was prompted to take action because they had previously experienced their portfolios rocked by the dot-com crash and the financial crisis.

Of course, it's also possible that their investments were re-allocated to other 'investments', like cash in the bank, home renovations, discretionary spending (holidays, a new car, etc.).  That would be bad news for Baby Boomers saving for retirement!

Here's the kicker: In only 2012 YTD, these Baby Boomers may have 'lost' a potential return on investment in the 'high teens', perhaps even ~20% (with re-invested dividends).  The S&P 500 had rallied 13% Jan-Nov 2012.

Even the stodgy Dow index of 30 blue-chip stocks has gained nearly 10% YTD (before re-invested dividends).  Note that if you had invested in a small basket of e.g. 10 Dow stocks and say you were 'lucky enough' to have included Bank of America (NYSE:BAC), but not Hewlett Packard (NYSE:HPQ), you would have generated a return quite similar to - or even greater than - the S&P500 YTD rally mentioned above.

According to The Street, the best performing bond fund YTD for 2012 has been Wells Fargo Advantage CoreBuilder (WFCMX), with a return of 14% and an expense ratio of 2.11%.  This top-performing bond is managed for Wells Fargo by Michael J. Bray, who has managed to deliver a return since inception of nearly 10%.

A Baby Boomer looking to move cash out of stocks or ETFs would probably be well served considering this bond.  In fact, WFCMX may be one of the best 'parking spots' for your investment if you're looking to help mitigate risk, and perhaps avoid the stress of the stock market volatility.

Note a couple of important points:
1.  WFCMX is the only bond fund that delivered a double-digit return, YTD 2012.
2.  The expense ratio at >2%, compounded, will reduce the actual return commensurately.  [When you have a long position in equity (i.e. you own the stock), there is no expense ratio]
3.  WFCMX seeks total return consisting of current income and capital appreciation. The fund invests at least 60% of its net assets in municipal securities that pay interest exempt from federal income tax [but not the alternative minimum tax ("AMT")], up to 40% of the fund's net assets in municipal securities that pay interest subject to federal AMT, up to 40% of its total assets in below investment-grade municipal securities and up to 10% of the fund's net assets in corporate debt securities. WFCMX pays a healthy dividend.

Particularly of interest in the CNN article is this excerpt:
"While individual investors have been shunning the market, institutional investors, such as hedge funds and pension funds, have been significantly adding to their stock positions. They've poured more than $80 billion into stocks so far this year."

It is possible that all the strategies above may end up positive, and I certainly hope that will be the case.  If you remained invested in quality S&P 500 or Dow stocks, your YTD gains would easily absorb recent volatility, e.g. during political wrangling about the Fiscal Cliff and Debt Ceiling.  If you moved your investments out of stocks and into bonds, I hope that the summary above will assist with planning when you speak with your financial advisor.  

The 'smart money' is getting into stocks (i.e. the people who do this for a living, like hedge funds & pension funds) while small investors - who are spooked - are getting out.  Both may prove correct, medium term?  If you are a smaller investor unable to accommodate the turmoil and ups-and-downs of the stock market, make sure you are educated, know your costs, and find a good alternate home for your investments.

Whatever you and your advisor decide, please aim to achieve personal financial literacy... and make sure you continue to spend less than what your earn!

Common forms of payment (simplified)

What is a check (or cheque)?
A check is a 'withdrawal slip' from your bank account, made payable to another person.  Instead of going to the bank and withdrawing money to pay someone, you fill out a check and make it payable to someone, or a company.  

It's easy to use and write a check:
1. Write the payment date in the appropriate line
2. Write who to pay in the line that says "Pay:"_____, e.g. ABC Company, or Joe Smith
3. Write the amount in words in the line below, e.g. One hundred and 25/100 (dollars)
4. Write the amount in numbers in the box, e.g. $100.25
5. The account owner signs the check on the signature line (bottom right)
6. The "memo/for" line allows you to write a short description of the transaction, e.g. "utility bill"

Note: a check has a unique number, e.g. 2400 (above).  Other numbers include the bank/branch routing number (usually bottom left) and the owner's account number (bottom, to the right of the routing number).

Personal risk: Checks can be stolen, and used by other people (writing your checks to pay someone, or cashing your checks intended for someone else).

Business risk: People pay other people with checks that are sometimes drawn on accounts, without sufficient funds to meet the payment value.  This results in checks returned to the depositor (the person who banked the check) marked "Insufficient funds" (or similar).  The person who was paid will then need to contact the payer to retrieve funds in another way, often with great difficulty - that is why many retailers do not accept checks.
What is a credit card?

A convenient method of payment, accepted at most businesses, allowing the owner to purchase something without having to first draw cash from their bank account, before they go shopping.  However, the bank is lending you money, and most often at a very high interest rate (if you don't pay the outstanding balance in full when you receive your credit card statement).

Unlike the administration required to write a check (above), a credit card is simply presented and the retail store's banking machine will process the transaction automatically.  When you purchase amount has been approved, the bank has just extended you a loan.  Because your loan is unsecured (i.e. you have not provided the bank with any security to cover your loan), there is a cost to borrowing.

Personal risk: Your credit card can be used by someone else.  Although you will be able to convince the bank that you didn't make the purchase, protecting you in the event of fraud, this sometimes takes a lot of time and can be stressful.  Your credit card has to be safeguarded in the same manner as you would protect your checks or cash.

Business risk: Very little.  If someone has fraudulently used your credit card and the retailer did everything required of it to ensure 'good faith', they won't lose any money.  The business receives payment 'instantly', less a credit card fee deducted, as per their agreement with the credit card company (or bank).
What is a debit card?

A debit card creates an "electronic check", and it is used like a credit card.  Debit cards often look like credit cards.  Banks often issue debit cards with the marks "Visa" or "MasterCard" on the card, making it appear to look like a credit card, and offering the account holder the convenience of payment "accepted wherever major credit cards are accepted."  You make a payment in the same manner as with your credit card, except that you would be required to enter your unique identifier, called a PIN (Personal Identity Number).  

Unlike a credit card (which is a bank loan), a debit card transaction allows the retailer to receive payment immediately, and your bank account is reduced by the purchase amount.  If you pay a retailer $100, the retailer receives $100 immediately (less a small percentage fee, e.g. 2.5%), and your bank account balance is reduced by $100 at the same time.

Unless you have overdraft (loan) protection attached to your checking account, you cannot spend $100 via your debit card, if you do not have at least $100 in your bank account. Retailers therefore prefer debit cards to checks, because the risk of receiving a check drawn on an account with "insufficient funds", returned a few days later, is mitigated.

Personal and business risk: As above, for credit cards and checks.

What is cash?

Cash currency: a paper monetary system used in place of bartering in our modern economy.  Instead of paying e.g. for 1 sheep with 100 chickens (called bartering), I could buy 1 sheep with e.g. $100 in cash.  Less cash is used every day in developed countries, as more and more people use electronic banking methods (above).

Individuals exchange cash (or currency) hand-to-hand every day, especially for small purchases, like a cup of coffee.

Governments print cash.  That is why every country has a different currency (name, design, etc.).  Buyers and sellers in different countries also exchange currency, and this can be referred to as "foreign currency exchange."  Currencies are exchanged at a certain rate, also sometimes abbreviated as "FX rate" (foreign currency exchange rate).  The rate between different international currencies is determined by the market, or supply and demand.  For example, the more U.S. Dollars there are available, the lower the U.S. Dollar value would be vs. other international currencies.  More about this later.

Personal and business risk: Cash is easily exchanged anonymously, and the holder of the cash is deemed to be the owner of the cash.  Don't send someone cash in the mail!  If I buy something with a $10 note, no-one will ask me where I got it from, or whether it's mine.  However, if you walked into the bank to deposit a large amount of money in cash, they should ask you where/who/how you obtained the cash.

There are many ways to transfer cash from one person (or business) to another.  Other common methods include bank wires, bank checks, electronic funds transfers (or ACH in the U.S.).  These are more sophisticated payment methods, commonly used in business, and I will cover these in a later post.

In a next post, we'll explore basic budgeting - why and how?

Becoming financially literate is essential, and managing your money - cash, cards or debt - is a core skill every young person should have!

Monday, December 24, 2012

Macro-economic 'bubbles popping'

By now, every person on the planet already knows about the housing bubble that effectively eliminated middle-class 'wealth' in the United States and most other developed nations.  I added quotation marks around the word wealth above, because most of these middle-class citizens didn't own the wealth in their residential property in the first place, but only the imaginary gains that would be achieved if the property were sold, less the mortgage owing, or outstanding. 

In reality, as sellers (assisted by over-zealous realtors) push home prices ever higher, combined with a decreased cost of borrowing (mortgage rates are at an all-time low), people kept buying larger and more expensive homes - certainly paying more than the replacement cost of the house by far - and living beyond their means. Today, if the outstanding mortgage is greater than the possible sales price of the house - as is the case for many homeowners across America - we refer to them being underwater.

However, there are two bubbles that will cause future corrections in the near- to medium term.  

These are:

1. Student debt

American and Canadian parents (and parents from other countries also, but I can only comment on what I know), have been indoctrinated to believe that their children are entitled to a college education.  This is regardless of the often dire personal financial situation of the parents. 

Many parents - well intended, no doubt - had used HELOCs to help fund the cost of education, helping exacerbate the situation described above.  Using their residential property as an ABM, they kept borrowing against the fictitious future resale value, feeling confident in their poor financial/lifestyle choice for two hopelessly incorrect reasons:

(a) the value of their home will keep going up, and
(b) their kids won't be able to get good jobs without a college degree

Now, as U.S. unpaid student loans approach $1 trillion, these young graduates can't afford to repay their debt, mainly because they cannot get work commensurate with their expectations (or entitlements) as a college graduate, inclusive of a salary high enough to allow them to repay the debt. Many work in retail for minimum wage, because that's the only job they were able to get hired for.

Worst, the parents are often saddled with the first mortgage, a second one, a HELOC... and an adult child back at home who cannot find good employment.  The government - mismanaging federal student loan programs just as badly as they mismanage other social programs - offer debt forgiveness, refinancing, etc. to students who would perhaps have been better off without the debt, or $200,000 college degree!

How will this situation end?  Regrettably, not well... and the summary above only scratches the surface of a growing financial burden and future bubble, ready to pop!

2. Property tax

You may have seen a few media reports about a housing recovery. If you believe those, or the bluster from politicians during recent election campaigns, you're in for a rude awakening.

One of the primary reasons resale properties (and new, but perhaps to a lesser degree) cannot sell is because of ever increasing, burgeoning, property tax. Property tax on a residential home is no longer related - in any way - to the value, property size, acreage, number of rooms, frontage, etc.  

Property tax may be mathematically based on some combination of these factors - i.e. if your neighbor's house is larger, she may pay more tax, pro-rated - but the actual gross amount of the tax, or the total due each year, is required as a contribution to your local government's unaffordable compensation schemes, pensions to support retired workers, and some of the cost required to fund services (like schools, roads, etc.).

In fact, if you were to take the time and trouble to review, even at a high level, your local town's budget, you will be amazed to see most of your property taxes are being allocated towards compensation (salaries, pensions).

This next bubble is already in existence, a problem exacerbated by falling property prices. With the low cost of borrowing, every $100,000 of mortgage debt costs the average person with reasonably good credit, less than $500/month.  That means that a $200,000 mortgage would cost the borrower less than $1,000/month.  This sum may be considered affordable to most  middle-class Americans.

However, the property tax in States like NJ and CT (that I'm most familiar with) often exceed the cost of the borrowing.  For example, if the property tax on a house in these 'bankrupt states' runs at $12,000 annually (a common scenario), the potential buyer is faced with a dilemma: while the $1,000/month mortgage payment may have been affordable, the additional $1,000/month makes the total cost of ownership unaffordable (especially considering utilities, insurance, ongoing maintenance, etc.).

The result is twofold: (1) people who may have aspired to home ownership - regardless of the reason - keep renting and (2) local governments under ever increasing pressure to fund and support the union demands of their existing and retired employees, have ongoing downward pressure on their incoming revenue (as owners default, file for tax value re-adjustments, leave the town, etc.), with ever increasing costs (higher pensions and medical insurance for retired employees; higher wages and benefits for current employees).

So... what happens now? Some towns and some homeowners file for bankruptcy; few refinance and change their ways.  Next bubble? You betcha... the cost of funding government in its current state is simply unsustainable.

The fix is fortunately quite simple.  Read "Should your kid go to college," Part 1 and Part 2. These postings should at the very least help you address the college funding crisis with a logical and common sense approach to the question of borrowing.  As for the property tax bubble - I can't offer to fix that, and it will burst under the pressure of non-sustainable government spending (unfortunate for us all).  However, the basic fix is really simple... buy what you can afford, based on your family requirements, and NOT to impress your family, colleagues and/or friends.

It's the most basic of all financial literacy: Live within your means!