Financial Planning for Young Adults: Credit - ProfBob

[Pages:22]Financial Planning for Young Adults: Credit

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From: James L (Jim) Cosgrove...jimcos05@

28 Credit Q&A's

Page 1 Q: What is good debt and bad debt? Q: What is FICO?

Q: Who is Experian?

Q: How can I check my FICO (credit) score? What's a good score?

Page 2 Q: Is it true that the more credit cards you have, the higher your credit score will be? Q: How can I build up good credit and improve my credit score?

Q: Do credit cards with high rates look bad on my credit report?

Q: I've had a bad credit record, but then cleaned it up. How long will my credit rating suffer?

Q: How can I find out what's in my credit record?

Page 3 Q: Why do credit card companies target offers toward students? Q: Is there any way to stop getting unsolicited credit card offers in the mail?

Q: Where can I find the best deals on credit cards? How can we avoid credit card

offers that seem tempting, but may have strings attached? Q: What's an APR? Are there good ones and bad ones?

Page 4 Q: At what age would you recommend getting a credit card? Q: Does my parent's credit history and condition impact mine? Q: How much debt is too much? Q: How important is it to build credit at a young age? Q: How many credit cards would you say are necessary? Q: I have no credit history right now. How should I go about creating one? What's the

best way to do it? Q: Does paying my utility bills (PG&E, phone, cable) on time help build credit? Q: I'm a full-time student and I'm having a hard time making ends meet. Should I quit

school for a while and pay off the loans or stay in school?

Q: Is it possible to estimate my car payment before I go to buy or lease a car?

Q: Does bargaining with a creditor work? Can I haggle my way out of a debt?

Page 5 Q: What tips would you give to get out of debt? How can I improve my situation? Q: Are those infomercials you see on TV to lower your debt true? Q: Jim, did you have student loans?

Q: I'm curious about why we as a nation, have so much debt. It seems kind of dangerous. Are we headed for an economic Armageddon?

Page 7 Q: Where can I go for more personalized help in solving my debt problems?

Appendices

(A) Wall Street Journal article titled "How to Boost Your Credit Score," dated November 19, 2005.

(B) From Yahoo Finance, "Why It Pays to Live Within Your Means."

(C) "Ten Things Your Credit Card Company Won't Tell You." From Smart Money, January, 2006.

(D) "Why Americans Aren't Saving"

(E) References.

Page 1

Q: What is good debt and bad debt? A: Good debt is an obligation you assume that will help you buy an asset that is

expected to appreciate in value over time or eventually produce income. Examples are loans to start a business, buy tools or capital equipment that will help you produce something of value, acquire education/skill development, buy real estate, make home improvements, and perhaps high-quality some collectibles and art.

Bad debt is an obligation you assume to pay for something that will either be used up by the time you pay for it, or will depreciate in value over time. Examples are autos, vacations, clothes, entertainment, furniture, appliances, restaurants--many of the things generally referred to as "consumer debt."

Q: What is FICO? A: FICO stands for Fair Isaac Company. They created the original credit scoring

algorithm. Experian enhanced it so it could be used to evaluate credit risk. Several good resources will provide more information on FICO. They can be found at: and .

Q: Who is Experian? A: There are one of three nationwide keepers of credit information:

? Experian (TRW) 1-888-397-3742

? Equifax

1-800-525-6285

? Trans-Union 1-800-680-7289

This is where your credit history resides.

Q: How can I check my FICO (credit) score? What's a good score? A: There's a really nice and really free FICO Score Estimator at

. Begin by entering your actual information. After you get your estimated FICO score, go back and tinker with the inputs and see what happens to your score. For example, you might think one year ahead. You'll have an additional year of credit history. Maybe you'd reduce your balance, make on-time payments, and not open any new accounts. Then see how that affects your estimated score.

There's also a table in there that shows the range of scores and what kind of interest rate you'll get on a loan, based on the score. I'd say a good score is probably over 700. There's a good article about this at brm/news/credit-scoring/20031104a1.asp.

Page 2

Q: Is it true that the more credit cards you have, the higher your credit score will be?

A: Not necessarily so. What matters is your total balance-to-limit ratio, that is, the ratio of your total balance to your total credit limit. Keeping that ratio under 50% will net you a higher score. You can run this scenario on the FICO Score Estimator at . Do your actual situation first. Then go back and do other ones with various combinations where you have more credit cards and higher balances and see what happens.

Q: How can I build up good credit and improve my credit score?

A: Pay your bills on time. Keep your balance-to-limit ratio low. Build a credit track record. Longer is better. Have a mix of loans: credit card, auto, home mortgage. Keep credit file inquiries low.

Q: Do credit cards with high rates look bad on my credit report? A: No. It just hinders your financial progress!

Q: I've had a bad credit record, but then cleaned it up. How long will my credit rating suffer?

A: In the FICO Score Estimator, there's a question that asks if you've ever gone through a negative financial event (bankruptcy, tax lien, foreclosure, repossession, or referral to a collection agency) in the last 10 years. That's a clue. The bad stuff will haunt you for about 10 years.

Q: How can I find out what's in my credit record? A: Federal law entitles you to a free credit report each year from any or all of the

three nationwide credit reporting agencies. Go to to get yours. It's also a good idea to get one just to make sure there isn't any fraudulent activity in it!

The three credit reporting agencies are Experian/TRW, Trans-Union, and Equifax. All three have little quirks and nuances of their own, mainly to differentiate themselves.

Be forewarned that there are plenty of imposter sites with names similar to looking to trick consumers into buying their credit report, so just make sure you're on the right web site. If you have doubts, go through the Federal Trade Commission's web site .

Page 3

Q: Why do credit card companies target offers toward students? A: Imagine being on the other end of this deal, as if you were the bank or credit card

issuer. What do you know about young people?

One, you know they're eager to get out there and get cool stuff so they can impress themselves and their friends. You know they're going to use the card. And you know they're going to use it right now. "Deferred gratification" and "fiscal discipline" are not in their vocabulary.

Two, you also know they're short on cash because they probably don't have a regular, full-time, decent paying job yet. They'll use the card and make minimum payments. You get to charge huge interest rates on the ongoing balance.

Three, you know that they have a whole lifetime of spending in front of them, and the sooner they get comfortable with the buy-on-credit habit, the more money you'll make. (Did you know that credit card issuers skim about 3% of cash register receipts most in stores where customers use their credit cards?)

Four, you know you'll make excellent money on the interest charges that will accrue because the kids are going to carry balances. (Check this: Your bank pays its savings account holders 4% while it makes 10% or more on credit card interest! Is this a cash cow or what!? The shareholders love you.)

And finally, the truth of the matter is that every demographic gets hustled, just for different reasons. Peak income earners get hustled because thy have high incomes. Retired people get hustled because many have a lot of home equity that might be liberated and spent. It goes on and on.

Q: Is there any way to stop getting unsolicited credit card offers in the mail? A: Yes! Call 1.888.5.OPT.OUT or logon to .

Q: Where can I find the best deals on credit cards? How can we avoid credit card

offers that seem tempting, but may have strings attached?

A: See and brm/rate/cc_home.asp. Not only will you find all the cards, but there'll be additional information about any attached strings.

Q: What's an APR? Are there good ones and bad ones?

A: APR stands for Annual Percentage Rate, which, because of the way interest accumulates, is always higher than the base, or stated rate. This is nice when you're investing, but not so nice when you're borrowing. Rates fluctuate over time, but you can check current ones at places like , , or .

Page 4

Q: At what age would you recommend getting a credit card? A: At an age when your income allows you to pay off the balance each month. In

other words, you will never pay an interest charge.

Q: Does my parent's credit history and condition impact mine? A: No. Your parent's credit history and condition is not reflected on yours, and yours

is not reflected on theirs.

Q: How much debt is too much? A: Warning signs are when you can't make even the minimum payment; when total

debt (excluding mortgage debt) exceeds about 30% of annual income; when you have to think about how you're going to make the next payment.

Q: How important is it to build credit at a young age? A: Not very. There will be plenty of time to build credit when you get a job and earn

income that will support debt payments. I would focus more on developing a "how to save" habit than a "how to spend" habit.

Q: How many credit cards would you say are necessary? A: One, simply as a convenience and to help establish a credit record.

Q: I have no credit history right now. How should I go about creating one? What's the best way to do it?

A: Get a no-fee Visa or Master Card. Use it (gently). Pay off the balance each month. All other things being equal, you'll probably have an improved FICO score in a year.

Q: Do paying my utility bills (PG&E, phone, cable) on time help build credit?

A: Not necessarily, because they are not credit transactions. However, not paying them could result in some annoying consequences! Like losing service.

Q: I'm a full-time student. Should I be working to pay off my loans?

A: Congratulations on being diligent about getting your education. I'd say, stay focused on getting the best grades possible, and then after you graduate and get a job, apply that same energy to debt elimination.

Q: Does bargaining with a creditor work? Can I haggle my way out of a debt? A: I've never looked into this because my sense is that it's unethical, unless of

course, you were injured or ill. If you incur a debt, you also incur a responsibility to honor it.

Having said this, it's perfectly fine to attempt to negotiate a payment settlement schedule that suits both parties. Just remember this is not the flea market.

Page 5

Q: Is it possible to estimate my car payment before I go to buy or lease a car? A: Yes! A calculator can be found at ?fire=1. Also, you can

calculate the cost of buying versus leasing at .

Q: What tips would you give to get out of debt? How can I improve my situation?

A: One, stop creating new debt. Right now. This moment. Cut up the card(s). Two, make a plan to pay off existing debt. Write it down. Make a hand-drawn graphic. Post it someplace where you'll see it everyday. Include motivational factors, like affirmations, to help you along. Three, tell a friend or someone else what you're up to, ask for their support and encouragement, and periodically give them a simple status report. Four, reward yourself along the way for making progress, and at the end for achieving your debt reduction goal.

Q: Are those infomercials you see on TV to lower your debt true? A: I don't know. I've actually never watched one because I don't watch a lot of TV.

My guess is there's a hook in there somewhere. (As for television, I watch Charlie Rose once in a while, an occasional PBS documentary, or maybe catch the last two minutes of an NFL payoff game. If it was up to me, I wouldn't even have cable, but my wife insists we do.)

Q: Jim, did you have student loans? If you did, how did you pay them off? A: I didn't have student loans. I had jobs.

Q: I'm curious about why we as a nation, have so much debt. It seems kind of dangerous. Are we headed for an economic Armageddon?

A: Simply put, we have debt because people want stuff and they want it now. And believe me, there are earnest and serious on-going discussions and debates on this topic in government and academic circles. But since America has a relatively free economy, even if a conclusion was reached, the political ramifications would make the selection of monetary policy actions difficult at best and counterproductive at worst. The most direct interventions are the discount rate decisions that come from the Fed (the Federal Reserve Board). Everything else is largely a function of economic market forces and will probably remain that way.

Page 6

An interesting piece titled "Spendthrift Nation" was recently published (11-1005) by the Federal Reserve Bank of San Francisco (FRBSF). The paraphrased gist of it is this:

The factors that appear to be driving the secular decline in savings (and the commensurate increase in debt) include rapid increases in the stock market and residential property wealth, which households apparently view as a substitute for the quaint practice of putting money aside from their paychecks each month.

Rapidly rising asset prices (stocks and homes), fueled by low interest rates and the proliferation of "exotic" and "creative" financing products have sustained the boom in driving household debt relative to disposable income to record levels.

The ratio of household debt to personal disposable income (see the chart below) has risen from less than 60% in 1960, to about 64% in 1984, to nearly 120% by 2004.

I think all we can reasonably conclude is that some unusual risks exist in the credit system. (If that sounds Greenspan-esque, I apologize.) If it's true, then it's possible that a reckoning could develop at some point in the future. Personally, I don't want to be in front of that train. And the best way to sidestep it is to adopt a personal policy of conservative and prudent debt management.

The full article can be found at . Under Popular Content, click on Economic Letter.

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