A Plan For Young People

This post is a continuation of a topic I started in Intro to Credit Gaming - Part III, which is that of a young person just starting out in the world with little or no credit history. As a somewhat young person myself, I have been there recently and can offer direct advice on the matter, as it's all stuff that I've done personally. If you're a typical college student, 1) You don't make very much money and 2) You're still counted as a dependent on your parents' taxes. #1 makes it hard to get credit (ever try to get a real (i.e., unsecured) credit card with $10,000 in claimed yearly income? Hahaha!). But #2 makes it easy to use a little trick to get credit. On credit apps, they never ask for your personal income; they ask for the household income! As long as you are claimed as a dependent on your parents' taxes, you are still technically a part of their household, even though you may live in different states.

So, simply write in an approximate amount for the total household income, including both parents' incomes and any other dependents'. Assuming that your family isn't barely scraping by, it should be no problem for you to get lines of credit in the $1k range, even with no credit history.

Of course, I am in NO way saying that you should USE all of that credit that you can get from inflating your income. Credit card debt is definitely a life-sucker. I ended up about $8k in CC debt a couple of years out of college, and it is no fun place to be. (And I know that $8k is pretty minor compared to many others' experiences!) Use the credit card as if it were cash; if you can't afford something, don't put it on your credit card! (There can be exceptions to this rule which I will discuss in a later posting, but only if you know yourself to be responsible with your credit.) If you cannot trust yourself, lock up your credit card somewhere and set it up for automatic payments of your cell phone or other bills to the tune of $50-$100 a month. Pay off your credit card every month.

All of the advice presented here is intended for responsible individuals who have enough self-control to keep from over-spending. It is intended for the person who wants to maximize his credit score as if it were a game. Falling deep into debt is an easy way to lower your credit score very easily. In this post, I am trying to tell you how you can establish a credit history when you are young and have very little income. Above all else, you do not want to establish a BAD credit history. (Note: Just carrying a lot of debt will not give you a "bad credit history," but it will depress your credit score until you pay off the debt. Missing a payment will definitely be a 7-year negative mark on your credit history, though.) If you cannot trust yourself with a credit card (if the thought of doing this scares you at all), you may want to hold off on this whole thing until you are a little more mature. For example, if you have never held a job or a bank account at all, you probably do not have the basic financial skills necessary to do this.

So, my "plan for young people" would be the following:

1. Get your first credit card ASAP, using your parents' income on your app if you have little or no income of your own.
2. Get subsequent cards every 6 to 12 months, and ask for credit line increases on your cards yearly.
3. Spread your cards out. I recommend one from every major company: Visa, MasterCard, Discover, and American Express. If you always buy gas from the same gas station, get their branded card if it will give you a discount. If you have frequent flyer miles with a particular airline, get a card that will earn more miles. There are many credit card benefit programs out there, so shop around. Always avoid annual fees. I will write later about choosing a credit card, but this short piece of advice is good for now.
4. After you get 4 cards (one from each of the major companies) you should stop unless there is some particular reason to get another one. Pay off all of the cards every month, online. It is very easy to set up a certain day of the week (usually I take Sundays) and log into ALL of my credit card websites, as well as my bank account, to see what is due. At the moment, I am paying off all of my cards as soon as a statement is generated. It takes about 45 seconds to set up the payment online, and in most cases it can be processed the same day. (It will take longer the first time you pay online, because your bank account has to be linked. This delay, which may be several days, could cause you to be late if you wait until the due date to make your payment.) This is probably the way you should do it too, until you reach a place where you can use more sophisticated methods. It saves you from having to worry that something is overdue. Check your online account weekly and pay as soon as you get a statement.
5. By the time you graduate from college and start working, you will have a solid foundation for your credit report. You will have a solid history of payments (35% of your FICO score), and your credit limits will be bumped up so that you can have a good debt to limit ratio (30% of your FICO). You will also have a good start on the 15% length of credit history component (and the sooner you start, the better off you will be).

Note: I had to change the timestamp on this post, as I had originally started it last week and saved it as a draft. I had no idea that Blogger would keep the original time that I started it! When I first posted it, it was 3 posts down the page. I will try to keep that from happening again, and in general, I am going to try to keep from editing posts that have already hit the page.

FICO vs. FAKO

Today I came across a post a Make Love, Not Debt entitled FICO and the Mortgage Catch-22.

I just got my credit score, which is based on the new Vantage Score model. My current score is 725 on a scale of 501-990. According to the credit score analysis, one of the primary reasons my score is so low is that I "have no real estate accounts."

More info on the Vantage Score

A few months ago, Casey Serin of I Am Facing Foreclosure committed the same mistake, pulling his TrueCredit score instead of his actual FICO. (See comments on the first link for people criticizing his choice of credit score and telling him to get his real FICO.)

What's the problem? A credit score is a credit score, right? Well, yeah, but not the REAL credit score. There is The One True Credit Score -- FICO -- and then there's a bunch of pretenders (at least in the US). According to Wikipedia, the Vantage score is up-and-coming and may start to replace FICO. This looks like a bunch of politicking to me. The Vantage score is backed by all 3 credit reporting agencies, which is a plus for it, but it looks like they basically came up with it in order to avoid paying royalties to Fair Isaac. When I see a bank pull my Vantage score, I'll start believing in it, but for now it just looks like a power play by the credit agencies. Even if it receives a lot of promotion by the credit agencies, it will take years for it to achieve any real market penetration -- lenders are already comfortable with the FICO, and switching to another system will require a long period of recalibration.

So while Vantage and TrueCredit are "actual credit scores" that obviously take into account much of the same information that FICO takes into account, the scoring process is different and the final score will be very different. Vantage goes from 500 to 990 -- almost the same range as FICO (covering about 500 points) but bumped up about 150 points on both ends. This is probably a psychological boost to people who have a poor credit score, but it makes for confusion because you can't compare it apples-to-apples with the FICO, which is what everybody means when they talk about their credit score. It is easy to see the psychology at work; nobody wants a credit score (or SAT score, for that matter!) of 0, so all of them start at a few hundred points and go up from there. But these are all just numbers games. You could have a "TrueVantage Extreme Plus Credit Score" of 90 gazillion, but it wouldn't mean anything.

As a side note: based on MLND's post about her Vantage score, it appears that there is at least one significant difference between the FICO and the Vantage: the inclusion of mortgage debt, specifically, as a positive predictor of credit-worthiness. FICO does look at the types of loans you have (which I will look at very soon as Part IV of the Intro to Credit Gaming series), but that is mainly a revolving vs. installment debt calculation. It is kind of hard for me to believe that this mortgage component will play a big role in the Vantage score. Of course, a credit score is just a "best guess" prediction at how credit-worthy a person is; it considers a limited-yet-potentially-large set of information and distills it to a single number. Such a process is always fraught with peril, and always needs tweaking from time to time to match trends. Insurance companies have years and years worth of data that they sift through in order to determine how much to charge you for insurance. This is the same thing that lenders do, based upon your credit score (at the moment, almost exclusively the FICO score). Having a mortgage loan really doesn't seem like it could be that great of a predictor. I understand the knee-jerk "but if you own a home, you must be stable!" argument, but on the other hand, if you lose your job and run low on cash, you are going to keep paying your secured debt (i.e. your mortgage) and let your unsecured debt (credit cards, etc.) fall to the side. Credit card companies can't repossess your credit-purchased belongings! Therefore, in an app for a credit card or other unsecured line of credit, having a mortgage should logically LOWER your credit score. Not by much, mind you, but a bit. Anyway, enough of this speculation.

For the moment, the one and only credit score that matters is the FICO, unless your lender tells you otherwise. If you pull your credit score, you need to get the FICO. I have read good things about MyFICO.com but have not used it. I think they may be somewhat overpriced, but at least they are not pulling the wool over your eyes with a "FAKO" score. I get my credit score (FICO based on TransUnion) for free through my Washington Mutual credit card. I'm working on that post right now, and I will post it this week.

Intro to Credit Gaming - Part III

Or, Establish Credit - NOW!

After the juggernauts of payment history and debt/limit ratio, the next-largest factor in your credit score is length of credit history. The maximum length of credit history that appears on your credit report is 7 years or 84 months (looking at my most recent credit report from Equifax, it appears that their history only goes back to a maximum of 81 months -- close enough).

My own credit history is creeping up into the 7-year range (earliest account opening was in March of 2000), so it has not yet hit the maximum. Therefore, this is something that still holds down my credit score a bit. When I look at my credit score (which I will cover soon), I can see the "primary reasons" for my score (i.e. "why is my score lower than the maximum?"), and one of the two reasons is this:

The length of time your revolving/charge accounts have been established is too short.

This factor is based on the age of the revolving/charge accounts on your credit bureau report (the age of your oldest revolving/charge account, the average age of your revolving/charge accounts, or both). Research shows that consumers with longer credit histories have better repayment risk than those with shorter credit histories. Also, consumers who frequently open new accounts have greater repayment risk than those who do not.

So this is one of the reasons that my credit score is currently in the 770 range (the December update had it at 766 instead of 772) instead of the 830-850 range.

The only cure for this is time. There is no way to jack up this component of your credit score, other than to wait it out. In March, my first-opened account (opened when I was 19) will hit the 7-year mark. In September, the next oldest one will hit 7 years. After that, it will be another few years before my next oldest accounts will hit 7 years. There is nothing I can do about this except wait and keep those accounts open.

I read a lot of articles and blog postings by twenty-somethings who state proudly that they have graduated from college and have no credit cards. While this is good in many ways, it is bad for your credit score to have no credit history. If you take the effective range of credit scores to be 500 (from 350 to 850), and accept the claimed 15% weighting for this component, that means that this can affect your credit score by up to 75 points. That is more than enough to make the difference for many people to be approved for a loan or not; to get a lower rate mortgage or not; to move into a new apartment or not.

The "take-home message" from this is: if you don't have credit, get some NOW. You can't retroactively build a credit history when you need it. If you are young and currently have no credit, you are doing yourself a disservice. If you are older and have never had a credit card or other revolving credit account, you are doing yourself a disservice.

Of course, I am NOT suggesting that you throw yourself willy-nilly into a bunch of debt! I did not carry a balance on any of my credit cards for several years. I would charge maybe $50 a month to them each month and pay off that amount each month. Maxing out a credit card can be useful for other reasons (e.g. if you want a credit line increase to help out your debt/limit ratio), but it is not recommended that you do so without a plan and the financial wherewithal to pull it off without piling up a lot of interest. In my next post I will discuss a technique for young people to use to help them establish their credit history.

Intro to Credit Gaming - Part II

Continued from Intro to Credit Gaming - Part I

Keep your balance to limit ratio low. (In saying this, I am talking about aggregate balances and aggregate limits across all of your credit cards, lines of credit, etc.) This can happen in two ways: A) Keep your balance low in absolute terms (always recommended but not always possible); and B) Raise your credit limit. If you already have a credit card, you can call customer service and request a credit line increase. They may or may not do it, but even a small increase can drastically change things.

This ratio is not linearly applied to your credit score. In other words, there are "tipping points" when things start getting worse and worse. For example, the difference between 0% and 25% is pretty small, but the difference between 25% and 50% is large, and the difference between 50% and 90% is massive. If you are carrying a balance that is over 90% of your credit limit, your credit score will be severely depressed. For example, if you have $20k of credit limit and you've taken up $19k in debt, you are at 95%. This kind of ratio looks like the "kiss of death" to lenders, and you look like you are headed for bankruptcy. If you can open up ANY sort of new credit line (even something with a bad interest rate -- don't use it, just open it) or extend your limit by even a small amount (and of course don't utilize that extended credit), it can improve your score.

On the other end of the scale, you can preemptively increase your limits when you are not facing credit problems. Sometimes the CC companies will do it with just a simple call and request. If they are a bit more reluctant, they might require justification. You can do this pretty easily if you can give a reasonable excuse for it when you call. Tell them that you are buying a new $2000 computer and want to put it on your card. They will have no way of tying the credit increase to your $2000 purchase, so they will increase your limit and you won't actually have to spend the money. You can even do this online with some credit cards. Just enter a reasonable-sounding justification, and you will likely get the increase almost automatically.

Often the company will increase your limit as part of their regular (annual, semi-annual, quarterly, etc.) account review. Discover Card raised my limit almost yearly for the first 3 years with no prompting on my end. But if you do not use your card at all, you will not get these limit increases. Charging it up close to the credit limit and then paying it down every month will often do the trick. For example, if you have a card with a $2500 limit, charge it up to $2000 a couple of months in a row and pay it off. The company will smell blood and raise your limit, trying to get you to charge more.

This method is very effective. If you ask for a credit increase, it might add an inquiry to your credit report, depending on the policies of the company. But the decrease due to the inquiry is quite minor compared to the improvement to your ratio. (More on the effect of credit inquiries later.)

Opening up a new credit account is just as effective as increasing the limits on an existing account. I have a real-life example of this. During the same period of unemployment I mentioned above, I was nearly at the end of my credit rope. I had 3 CC's with about $8k in total debt (within $500 of the credit limits). I finally got a job that was quite well-paying, but I was going to have a bit of trouble making the payments until my first paycheck (which would be delayed nearly a month from my start date). I called American Express, who had been pestering me to apply for a Blue card (I already had a Gold charge card), and they offered me a Blue with a $10k limit. I was dumbfounded (the limit on this one card was equal to more than the limits on all my other cards combined), but I did it and transferred all of my old balances to the new card with room to spare and a 0% APR on the transfers for 12 months. (I got the entire thing paid off easily within the 12 months.) My credit score (which I monitor monthly... will discuss in a later post) shot up from the 550 range to the 660 range by the next month. That's a 110-point change by changing my ratio from over 90% to under 50%.

Intro to Credit Gaming - Part I

The first thing to know is what goes into your credit score. According to Wikipedia, FICO components are:

• 35% payment history (on-time vs. past due) -- goes back 7 years
• 30% ratio of current debt to credit limit
• 15% length of credit history
• 10% types of credit used
• 10% recent credit requests and recently obtained credit

These percentages are given as a rough starting point and should not be taken as gospel, but I doubt they are ever too far off from the actual calculation. The first thing you should notice is that there are two "big boys" which each are roughly equal to the other components combined. These major players are Payment History and Debt/Limit Ratio. As these are the largest components of your credit score by far, they are where you should focus your efforts. I will cover the first point now and save the others for later.
Always, always, always pay on time. If an account is no more than 30 days past due, it is not considered late. My current credit report shows no missed/late payments on any of my accounts, ever. I came close a couple of times. Once, I was basically unemployed, so my mom bailed me out on a car payment that I couldn't make for the month. It was nearly 30 days past due, and she didn't want me to ruin my credit score. Thank goodness! However, there is some question as to how badly a single late payment can hurt your score. I have read that one or two scattered missed payments won't really hurt you substantially (at least once enough time has passed, say 6 months or a year), but a recurring pattern will really do you in.
If you cannot pay on time, minimize the number of missed payments. This was my strategy before my mom bailed me out: I was able to pay all of my 4 credit cards' minimum payments that month, but I was going to miss the car payment. If I had skipped all of the credit card payments, I would have been able to afford the car payment. So rather than have 4 missed payments on my credit report, I aimed for just 1. Obviously I never saw how this played out, and I can't really do a test to verify this advice, but it seems fairly obvious.
Next time: Credit Limit to Debt Ratio!