Reality Check – Credit is Used for More than Just Loans

 Maintaining credit is important for more reasons than accessing credit cards.

Cash is King. Why Should I Maintain Credit?

Cut credit cards from your budget

Don’t charge your groceries

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 on 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. Revolving 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 we receive 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!

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Managing Personal Finances at Tax Time

 

preparing-taxes-at-desk

Recommendations for what to do with your personal finances at income tax time

For a country whose independence move started with a tax revolt, tax time in America typically splits our citizenry into three dominant camps of taxpayers, with only a small but vocal minority complaining about having to pay additional taxes. These three groups include those who have to submit a payment to the IRS at tax time, those who receive a tax refund/credit, and those whose taxes due or tax refund is so small that it is inconsequential.

GROUP 1: The first group tends to be our most vocal. They come from a long line of Americans who detest taxes. Whether they are small business owners who find themselves owing more taxes than expected, whether they started a new, higher paying job the previous year and did not adjust their W-4 accordingly, whether they were on unemployment and elected not to have taxes taken out each week, or perhaps they had a child turn 17 last year, leading to the loss of their child tax credit, this group finds that they owe Uncle Sam and, likely, their state coffers a large income tax payment. Although constituting well over 10 million taxpayers, this group is probably the smallest of the three.

CONSIDERATIONS: You have a couple options to minimize the pain of coming up with a large income tax check in the future. First, and most obvious, is to adjust your W-4 in order to increase the amount of income tax paid with each paycheck. Yes, this means a smaller paycheck, but it also means less pain each payday. Use the IRS Withholding Calculator to figure out what your ideal W-4 might look like. The second option is actually NOT a good option. Some people believe that they can set up their W-4 so that NO income tax is withheld and that they will just pay their entire income tax at once. As the justification goes, it is better to keep the tax in their own account and let it accrue interest until Uncle Same requires it. The problem is that we have a “pay-as-you-go” income tax system, and the IRS wants you to pay taxes with each paycheck. There are exceptions to this rule, but otherwise, you may be penalized if you do not pay as you earn.

GROUP 2: This group includes those who have some well-organized finances or who have submitted a well thought out W-4 to their employer. This group is the least vocal and least animated at this time of year. If, after completing their tax return, they owe some money, it is usually pretty mild. If they are due a refund, it is similarly relatively small.

CONSIDERATIONS: First, stay the course. You have done well to adjust your tax payment to fit your paycheck. Take comfort in two facts: 1) you do not have to come up with a huge tax payment in the spring, and 2) you are maximizing your purchasing power by keeping as much money in your paycheck each month as possible. If we did have another recommendation, it would be similar to the one we share with everyone: make sure that you are paying yourself first with each paycheck. Before you pay bills or make your car payment or go grocery shopping, put money into a savings fund. Otherwise, it will never happen. Plus, if you are among the 40% of Americans who are building their savings funds regularly, come tax time, you will not feel envious of the next group because you will already have something pretty cool in your savings account: a cushion!

GROUP 3: The largest group includes the 8 out of 10 American tax filers who will receive an income tax refund or credit from generous ol’ Uncle Sam. The large majority of households ranging from low-income all the way through households with $200k of annual income get a tax refund. As any CPA worth his or her salt can tell you, the downside to this scenario is that the government is collecting more of your spending money throughout the year, holding onto it, and returning it to you the following spring WITHOUT interest. “So?” you ask. “My savings account earns so little interest that the government might as well hang onto it for me.” This reasoning fails to account for inflation. Averaging around 3.4% annually over the past century (though around 2% over the past decade), inflation eats away at your purchasing power. Consequently, if you allow the government to hold, for example, $100 of income tax for a year, by the time you get it back next year, you will be able to purchase less than 98% of whatever you could have purchased when you earned the money.
That said, given the fact that 60% of Americans contribute nothing regularly to their savings fund, this small loss of purchasing power is a small price to pay for providing 80% of American taxpaying households with a once-a-year savings fund distribution.

CONSIDERATIONS: If you know that you would struggle to contribute to a savings account if you paid fewer taxes and got more money in your paycheck, then it is understandable to look forward to a tax refund each year. That said, we still recommend that you consider adjusting your withholding so that you get more in your paycheck but still have the benefit of receiving a respectable refund next year. Either work with your CPA or check out the IRS Withholding Calculator to figure out the best withholding for your goals.

If, on the other hand, you insist on getting that huge income tax refund every spring, we recommend that you consider using it according to a plan, such as:

• Spend 30% of it on needs (e.g. replacing a broken washing machine)
• Spend 25% of it on paying down debts
• Put 20% of it toward short-term goals (e.g. vacations or an emergency fun)
• Invest 15% of it in your long-term security (e.g. 401k or a future down payment on a home)
• Spend 10% of it on something fun

Regardless of which group you find yourself in this year, it may change next year. Stay aware of how changes in your income or household will affect your income taxes and make an informed decision about whether to withhold more than recommended.

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Spring Cleaning Your Finances

Get your finances in order during this year's Spring cleaning!

Get Your Finances Organized As You Spring Clean

Spring is here with flowers and sunshine! With Spring fever in full swing, and as we clean up our homes and yards, we should clean up our finances too! The changing season is a good time to evaluate budgets and spending plans to become financially efficient.

Whether you have a lot of debt, just owe a small amount or anywhere in between; let’s spring clean! Let’s get rid of those services we don’t use, pay off our debt and get our savings going.

Services We Just Don’t Use

I know you are thinking: “This isn’t me, I don’t have any services I don’t use”.  I almost believe you. I thought the same thing about myself. Here is how I found my service that is no longer needed: Search for it. Start by gathering all of your bills. Yes, every single one. Now pretend you are NOT you. Pretend you are an auditor who is going to find a useless expense and question everything, be honest with yourself. If you haven’t used it in the last 3 months, do you need it? Are there charges from vendors that are not required for the account? Do you lease a modem for your internet service? How much does it cost to buy one? Here are a few more items to consider:

  • Are you using that membership you pay for each month or each year?
  • Do you need all those cable channels or do you need cable at all?
  • Are you reading the magazines you get? It’s better to cancel now than forget and be automatically renewed.
  • Closely review your phone bill. Do you have services you don’t use?
  • Are you sure you’re getting the best insurance rates? It might be time to shop around.

Create a Financial Overview

Now is a great time to get to know your numbers. Find your paper statements or check your accounts online to see where your checking, savings, retirement accounts, loans, and credit card debt stand. It may help manage your stress to have one place where you can update all your balances and can see progress toward your goals. You will also be able to see where you can make improvements. Once you’ve listed all this information, set a date every month to do another financial checkup.

Pay off our debt

Before you can pay off debt, you’ll need to organize and prioritize it. How should you go about doing this?

Remember in elementary school, there was a fourth-grade bully, Sam, who picked on the first graders? We would tell him, “Hey! Pick on someone your own size!”  Of course, he wouldn’t pick on someone his own size, because that wasn’t easy.

What does this have to do with debt? Well, we can take a lesson from Sam the Bully (Yes we remember you all these years later) about paying off debt. If you ask an accountant about how to prioritize paying debt off, a typical answer would be to pay off whatever account has the highest interest rate. Financially that would make the largest impact. There is just one problem… A lot of the time the account with the highest interest rate may have the highest balance. We need motivation. If no immediate results are perceived we can become discouraged. So, pick on the little guy! Yes, we need to become Sam the Bully and take on the small balances. It’s easy and when you take even just one out, you will be free of an obligation! You can then use the money from that account to pay other accounts faster. This will motivate you to continue and maybe even further motivate you to find more ways in your budget to take down the little guys faster! After one is down, work your way up!

Start saving now!

It seems counterproductive to save money if you’re in debt. You pay interest on the balance of the accounts and any money sitting in a savings account if applied, would lower your interest expense. Why have a savings at all? Because the unexpected will happen! The unexpected will appear suddenly with all its ugliness. We have to plan for it today! If you have no savings and an unexpected expense comes up, you may pay a lot more to finance it than if you saved for it. If you have no savings now, try to get to $100 as quickly as possible and keep it in an account that’s easy to manage and track. Then continue to build your savings to $500 on up.

If you’re in debt you’ll want to get to 1 to 3 months of expected expenses. This will help if you ever lose your income. After you are financially free, save 3 to 6 months for an emergency savings. Also, keep this in mind: For every $10,000 a year you make, it will take one month longer to find another job at a similar pay rate. If you make $50,000 a year you should plan to be job hunting for at least 5 months.

Get in the habit of saving. If your budget is so tight that you can’t afford to save, save $1. By getting yourself in that habit, once things change, you will be saving more. It’s hard to break a habit. Start saving today! 

What is next?

So you’ve reviewed your accounts for unused services, have a solid plan to pay off your debt and are on the road to a reasonable savings goal. Financial spring cleaning is done! You are free to enjoy some lemonade and appreciate the spring flowers!

Then start planning for the next season- summer vacation and increased air conditioning costs. If you continue to review your finances regularly, you can be assured that nothing is getting swept under the rug!

David Cay

AFCPE Accredited Credit Counselor

15 years experience

 

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6 Ways to Protect Your Personal Information

Take these precautions to safeguard your personal information and prevent identity theft.

How to Prevent Identity Theft

Way back when it was the norm to live off the grid and companies, like households, were only connected by phone calls, faxes, and hard copy data, identity theft wasn’t an everyday concern. Now from the time we wake up to the time we go to bed, we navigate multiple instances in which our personal information is exposed and could be exploited. Here are 7 of those cases and the precautions you can take to further protect your personal information and identity.

Take Caution with Contest Entries

Not all contest entries, whether online or event-related, come with risk. The best way to go about participating is to limit the amount of information you include. A contest may reasonably ask for a name, contact number, and email address if these are the means by which they will contact you. Some companies hope to also receive a mailing address, which is personal information you shouldn’t feel the need to share, especially if you don’t want to end up on a sales list.

If including an email address, make sure you give one that’s separate from where you receive bills and bank statements. Before submitting any of your information, make sure the company has stated in writing that they will not sell your information or use it for something other than the intended purpose. As an added precaution, gather company contact information and screenshot or take an extra entry form with you for your records.

Share Less on Your Office Forms

Don't give out your personal information until your health office or potential employer asks for it.Providing information to dental, medical or other health offices may not seem like an unsafe practice. In some cases, your social security number may be required before medical procedures or to connect your insurance for billing. However, if you are paying out of pocket or are not familiar with the staff, providing personal information could put you at risk. How many eyes will see it and can you trust them all? Ever met a less than professional receptionist or billing specialist? Me too. You can always ask, “why is this information needed?” and “what will happen if I don’t provide it?” The office staff is far less likely to question or pressure you to provide it than you think.

Now, consider other ways you can apply this. Do you need to share your social security number in your first round of an employment application? You may not be offered the position and yet your sensitive information could be sitting in a stack of unprotected papers or kept in a database for who knows how long. How many people in that company will see it unnecessarily? The less you share your information, the better.

Protect Physical Property

Mail

Gone are the days that you can take your unopened “junk” mail and throw it in the trash. Even pieces of information such as the last four digits of your bank account or the combination of your full name and address can put you in financial danger. Thieves are diligent in collecting little bits knowing that this will allow them to steal your tax refund, take out loans, or open credit cards, bank accounts, or utility service, just to name a few. Fight back with a one-two process of blacking out personal information, then shredding it before adding it to the garbage.

Other steps you can take include removing your mail from your mailbox in a timely manner and being sure sensitive mail is always kept out of sight from guests in your home. You may even want to keep it under lock and key.

Social Security Cards

The same goes for social security cards. They are one of the most important pieces of information related to your identity. Someone could potentially impersonate you in order to take out thousands in student loans or receive government benefits. The extent of damage a criminal can do with your social security number will not be quick, easy, or painless to fix. The physical card should only be carried in your wallet when a situation such as new employment requires it. Make sure when Human Resources or medical billing requires it, that it is returned with urgency. In all other cases, it’s best if stored in a locked cabinet or drawer.

When it comes to both your social security card and number, carefully consider who among your loved ones can be trusted with your information. It’s very unusual to share it with family other than your parents, who have likely held these records safe for you until you reached adulthood. At some point, you should acquire all these records, especially if you have reason to believe these individuals may be using your information in a harmful or self-serving way. It’s also advisable not to share your number with a significant other until married or unified legally.

ATM and Computer Safety

Be aware of how predators target your personal information at ATMs and on your computer.

While the EMV (Europay, Mastercard, and Visa) chip in your debit and credit cards may help you feel more secure when swiping at checkout, in other ways you are no less at risk. Creditcards.com reports that since the introduction of the chip technology in 2015, theft in which a card is not present (CNP) has almost doubled.

As mentioned previously, individuals can steal your information simply by seeing your physical card. A criminal is more likely to use technological means to glean what they need to take advantage of your finances. You must be cautious in any instance that might leave you vulnerable. This includes using ATMs at the bank or gas station, linking bank account information to subscription services or online shopping sites. Theft attempts in the form of phishing emails are likely sent to your email address every day.

Check out the following articles for specific tips on how to use ATMs and computers safely:

Protecting Your Identity
Protect Yourself from Card Skimming

Phone Safety

While you may be use to getting fishy marketing calls, it may surprise you that according to the Federal Trade Commission, phone calls account for the highest amount of identity theft complaints. Mail and email related complaints were miniscule by comparison.

Over the years, these phone scams have come in a few varieties. Most recently, criminals have been impersonating the IRS and try to convince you to pay an owed balance immediately. In a similar scheme, someone may call telling you a relative is in trouble and you will need to send money to bail them out. In both cases, never relinquish banking account or social security numbers. Additionally, do not confirm any information they seem to already possess. Furthermore, don’t make a payment through any other suggested method.

If you feel the call may be legitimate, ask for the company’s name and location and end the call politely. Visit their website such as that of the IRS and call the number listed to address the issue in question.

A unique version of these scams consists of the caller asking questions that would require you to state your name or answer “yes.” The criminals can then turn around and use these recordings as voice authorization. Scrutinize the caller’s every word. When in doubt, hang up.

For an in-depth list of phone scams, visit the FTC website:

Phone Scams

Mobile Phone and Tablet Apps

You may not be a teenager or millennial, but it’s likely you have multiple apps on your phone. It may be email or GPS, or maybe Photos linked to your Google account. As harmless as these standard apps seem, without proper precautions, they can be a peephole giving predators a view of your information. For this reason, turn off your data connection when you are not using it, set passwords and screen timeouts for your phone and apps, and deny location tracking when you can.

In the article above, “Protecting Your Identity,” you’ll learn more than one reason why it’s important to avoid connecting your phone to WIFI networks in public places such as Starbucks or an airport. This can make your personal information accessible to anyone within a certain distance.

Lastly, as helpful as personal finance apps can be, do your research before signing up. What do the reviews say about how well they’ve protected others information? Is the company backed by a government agency? What liability do they claim in preventing theft? What level of security do they provide? Again, the rule of thumb is the less you share your information, the better. So, if a finance app is the way you want to go, limit how many you use and the extent to which they can manage your financial information.

The sad truth is that as more and more data turns digital and more processes are automated, identity theft will continue to rise every year. Be diligent in educating yourself on trends in identity theft and you’ll stay one step ahead.

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FICO Explained

Read about the 5 factors that influence a FICO score.

What Is a FICO?

When it comes to credit scores (also generically referred to as a credit rating), most Americans know that they are important and that they can have a major impact on our financial lives. However, very few know what goes into a credit score or just how influential it can be.

First of all, the term, “credit score” does NOT refer to a SINGLE scoring system. In the US, there are over a thousand credit scoring models in existence, created and used by hundreds of creditors and consumer reporting agencies. However, the most common credit scoring model (used in about 80% of all credit-based decisions) was developed by Fair Isaac Corporation (FICO for short).

Founded back in 1956 by Bill Fair and Earl Isaac, FICO manages products that help creditors to predict the rate at which an individual will default on a loan. An individual’s FICO score does not determine how much money he or she may borrow.

Rather, it provides a numeric rating of the risk to the creditor that the borrower is. The score ranges from 300 (extreme risk) to 850 (very low risk). Consider that most consumers with scores below 750 will end up paying higher interest rates than those who have worked to keep their scores above 750.

The score is based solely upon the information included in the individual’s credit report.
The five most important factors in a FICO score are as follows:

1. Payment History: This section considers your pattern of on-time and/or late payments. The more recent the activity the more influential the activity is, i.e. a pattern of recent on-time payments is more influential than late payments from 5 years ago.

2. Balance-to-Limit Ratio: This section compares your current debt balances to your potential debt (total credit limit) at a card-by-card and an aggregate level. This is also called “Usage.”

3. Length of Credit: This section considers how old the accounts are that are listed on your report, both on an individual level and overall average. You may consider closing a credit account from time to time. Be aware that closing any card that helps to establish your length of credit history may lower your credit score.

4. Pursuit of New Credit (Inquiries): This portion considers how much new credit you have recently applied for. If you apply for more than a couple lines of credit each year, the credit scoring model essentially wonders why you’re needing so much credit.

5. Credit Mix (Types of Credit): This section takes into consideration the variety of credit lines you have opened and/or used recently, including credit cards, retail store cards, mortgage loans, auto and other installment loans, consumer finance accounts, etc. Some variation in credit is preferred.

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