Welcome clickers from Train Wreck Central

aka IAmFacingForeclosure. I've decided to do this post backwards. The meat is up front. Introductory/explanatory stuff is at the end. Since you're here, read these "Intro to Credit Score Gaming" articles: Part I - Payment History, Part II - Balance to Limit Ratio, Part III - Length of Credit History, Part IV - Types of Credit Used, Part V - Recent Inquiries and Recent Credit. That's the core info. Other highly relevant posts: FICO vs. FAKO (I got "FAKO" from a commenter on IAFF. Thanks, whoever you are!). What to do if you're young and trying to establish credit. Get your credit reports (not scores) yearly from the government, but be aware of how the "annual" part works. I also discuss recent inquiries in more depth.

If you've read some or all of the above posts and want to find out your FICO score and maybe track it over time, please use this link to MyFICO.com (the best place to get your real FICO scores) which can also be found at the top and sidebar of every page. Oh, and there are coupon codes out there for MyFICO.com. Just use Google and you'll find them.

(Now the introductory/explanatory stuff -- I originally had this part at the beginning, but it started to run pretty long...) I have been keeping up with Mr. Serin's situation for quite a while now, and I had to temper my disgust at Casey (especially with this recent Australia bit) with my greed and desire to make some more money from this blog. I have mostly stayed out of the comments at IAFF, because you guys can be awfully intimidating.... but I've read a lot of the stuff on Exurban Nation (Duane posts especially), Nigel Swaby's blog(s), Caseypedia, etc. Anyway, back to my motivation in becoming a "Supporterz" (although if I had to, I'd say I'm a Haterz(TM)). That MyFICO.com referral link that you see at the top of the page is actually making surprisingly good money, even with the minimal amount of traffic that I'm already getting. I'd like to see if I can increase that, at least temporarily (who knows how long IAFF will be up).

Anyway, this blog has been fairly dormant for the past couple of months, for several reasons. One, my wrists are hurting, and I already have to spend most of my day at the computer for work (not a W-2 -- ha!). But really the main reason is that I'm pretty much out of stuff to say about FICO scores and how to improve them. I'm not one of those guys who can just retread the same old topics over and over when nothing has really changed. There's only so much to say about FICO scores, but I'm constantly surprised at how little people know. There are many misconceptions out there. I probably still have some misconceptions myself! I'm just one guy, and I don't know everything. So I may have gotten some stuff wrong, but I've been tracking my FICO score monthly for upwards of 3 years now, so I probably have a better grasp on it than most. If you disagree with anything that I've written about FICO scoring (or just have better information) then please leave a comment correcting me.

So, that's that. I hope you at least learn something while you're here, even if you don't get your FICO score at MyFICO (mercifully unlinked for your mental health).

Apologies and a Break

I apologize for the lack of posts lately. On top of being particularly busy (just bought my first real estate, which I may write up later), I also have started to feel symptoms of either carpal tunnel syndrome and/or tendinitis in my wrists. As my job requires me to use the computer, I am curtailing all non-job-related computer usage as much as possible. I am experimenting with different keyboards, trackballs, etc. and my wrists seem to be getting better. But still they start to hurt after a day at the computer.

I will still be reading other PF blogs, sometimes commenting, sometimes maybe even writing something here. But you should consider this blog on hiatus until further notice. Please continue to use it as a reference, as the important stuff (e.g. the Required Reading) will continue to be relevant.

GCS Required Reading

If you're a new reader, you should be sure to read through these "Intro to Credit Gaming" articles: Part I, II, III, IV, V.

These articles cover the components of the FICO score, which forms the basis of any advice that I might give. They really encapsulate the bulk of what I wanted to say when I started this blog. There is too much disinformation out there about the FICO score (which is the only score that matters). The most common advice that people will throw around in terms of gaming your FICO score is not to get new credit inquiries, which has a grain of truth but is hugely overestimated in terms of importance (as you'll find in Part V linked above).

I apologize for the infrequency of new posts in the past month or so. My job has kept me really busy, and then there's taxes, buying a rental condo, visiting family, and all kinds of other things going on. For now I am pretty much only writing new content when I have insomnia. Which, thankfully, isn't that often.... but that also means that I haven't been writing very often. Over time, my schedule will even out, and so will my blog activities.

The "Inverse Rule of 72" for Mortgages

Golbguru of The Tao of Making Money recently posted about the common "Rule of 72" for figuring out when your money will double, based on making an investment that makes a particular interest rate. If your rate is 7%, it will take roughly 10 years to double your money, etc.

Well, that got me to thinking, particularly when I had a conversation with my dad today about my parents' house. They have been in the house for about 10 years and have a typical 30-year mortgage (although they are making payments every 2 weeks in an accelerated payoff plan). We were wondering how much they still owed on the mortgage, and unfortunately such calculations don't come quickly in our heads, and I had no quick shortcut. I wondered: What if there is a quick "Inverse Rule of 72" out there? How long would it take to halve the principal when we're paying interest?

So tonight I used Bankrate's Mortgage Calculator to figure out a few tricks. In line with the "double your money" idea from the Rule of 72, I wanted to know how long it would take to pay off half of the mortgage. Taking it one step further, I wanted to see how long it would take to pay off just 25% of the mortgage. The formulae for the final approximations here are not exact, but they are quite easy to calculate and good enough for casual use. All of these figures are based on a standard 30-year mortgage. First we have a table of the actual values for the month/year when the mortgage will reach a certain paid-off point:

1/4 paid off
0%	6/07
1%	6/08
2%	5/09
3%	5/10
4%	6/11
5%	7/12
6%	8/13
7%	9/14
8%	9/15
9%	8/16
10%	7/17
1/2 paid off
0%	1/15
1%	2/16
2%	4/17
3%	4/18
4%	4/19
5%	3/20
6%	1/21
7%	10/21
8%	6/22
9%	1/23
10%	7/23

The 0% part is fairly obvious, and it forms the basis of our estimation formula. A 30-year 0% loan will be paid off halfway at the halfway point of the loan, or in the first month of the 15th year. One-quarter of the initial principal will be paid off one-quarter of the way through, or 7 years and 6 months into the loan. These form the baselines, and all other dates will be calculated from there. Now if you look at the tables, as you move up a percentage point, the target dates are pushed back by about a year per percentage point. At higher interest rates, there is a bit of compression at the back end of the loan, but a year is still a good estimate. There is only a 6-month difference between 9% and 10% to reach the halfway point (both occur in the 23rd year of the loan), but it is still 9 months between 6% and 7%. So as your interest rate gets above the "normal" threshold, the approximation will get less accurate for the half-paid scenario. For paying off one-quarter of the principal amount, each percentage point between 0% and 10% makes a difference of between 11 and 13 months, so one year is a very good approximation in that case.

So our final formula is:
1/2 Paid off: 15 years + 1 year per percent interest
1/4 Paid off: 7.5 years + 1 year per percent interest

Remember, these are all for 30-year mortgages! So, it will take roughly 22 years to pay off half of a 30-year mortgage at 7% interest and roughly 18 years at 3% interest. It will take roughly 10.5 years to pay off 1/4 of a mortgage at 3% and roughly 14 years at 7%. If you are interested in 15-year mortgages then you can just use the above formulas and divide your final answer by half.

Who just wants to be a millionaire?

A popular article on CNN.com talks about modern-day millionaires. And to that, I say: Who just wants to be a millionaire? The term has lost all of its cachet. Not to say that millionaires are losers; obviously they're doing much better than most of us.But it certainly doesn't mean what it used to.

The Oxford English Dictionary lists the first documented usage of the word "Millionaire" coming in 1816 from George Gordon, Lord Byron: "He is still worth at least 50,000 pds being what is called here a 'Millionaire' that is in Francs and such Lilliputian coinage." It is interesting that even back then, there was a question over what might truly be considered a "worthy" millionaire. Obviously currency conversion rates can wreak havoc with the term. you can be a Yen millionaire for roughly $8500. That's a pretty low bar to pass.

So, what's your own definition of a millionaire? Personally, I look back to roughly 1900 to 1920. The age of Robber Barons and The Great Gatsby.... the age when the term "Millionaire" was extremely impressive. Using the Inflation Calculator we can see the following current values for previous millionaires:

• 1900 Millionaire: $23.3M 2006 dollars
• 1910 Millionaire: $21.6M 2006 dollars
• 1920 Millionaire: $11.3M 2006 dollars
• 1950 Millionaire: $ 8.2M 2006 dollars
• 1970 Millionaire: $ 5.3M 2006 dollars
• 1980 Millionaire: $ 2.7M 2006 dollars
• 1990 Millionaire: $ 1.6M 2006 dollars

Based on this, I'd have to go with the nice round figure of $10M to be what I would personally consider to be a "modern-day millionaire." That's the kind of money that you can't get by being an extremely frugal teacher or janitor like those described in The Millionaire Next Door (the very fact that there can be a "Millionaire Next Door" is an indication of how much the term has slipped). That kind of money almost requires that you be very successful in what you do. Of course, there will always be lucky people like heirs, lottery winners, and early employees (as opposed to founders) of startups who end up with $10M+ net worth. But it's still a very rarefied group, and it's my goal to end up there.

Re: JLP's Subprime Lender Mess Question

In QotD: Subprime Mortgage Mess - Who's to Blame?, JLP at All Financial Matters poses the question: "Who’s to blame for the subprime mortgage mess? The lenders or the borrowers? Or, should the blame be shared?"

He got a lot of interesting replies, and this was going to be one of them, but I started writing and it got very long, and then I got pulled away and ... blah blah blah. The point is, my answer is here now.

They're both to blame for their own part of the problem.

Anybody who defaults on a loan is obviously to blame for 1) overextending themselves and/or 2) not understanding what they were getting into. That is an individual problem, and each individual is responsible for their own problem.

Lenders are at fault for the bigger, aggregate problem. They made stupid loans, quite simply. They made loans that they couldn't cover. Millions of them. Millions of poor business decisions, pure and simple. They are totally at fault for that and therefore bear the majority of the responsibility for this whole thing. Loaning to subprime borrowers is inherently risky. You go into it knowing that some percentage of them will default. It is the job of the lender to figure out that percentage and set their rates accordingly to keep from going bankrupt.

Your average individual American cannot really tell you how much house they can afford and how much they will be able to afford 2, 5, or 10 years down the road. A bank, with lots of smart people working for it, using tons of actual data to make predictions, can. The credit game is one of "if you build it, they will come." If you decide to loan money to people with poor credit, people with poor credit WILL decide to borrow money. If they default (which some will, no matter what) then you have nobody to blame but yourself for lending them the money. If you create lending programs specifically for people with poor credit, and then advertise them in every newspaper and every other broadcast medium, guess what? People with poor credit will apply for that credit! And if the company is stupid, it will approve more than it should at lower rates than it should.

We are all familiar with the typical bad image of a company with more marketing acumen than actual good products. They come up with something stupid, and then, in order to sell it, they use marketing to "create the market." They generate demand to meet their supply of the product -- demand which, like the product, was nonexistent before. And then millions of people end up with Pet Rocks or Food Dehydrators feeling like idiots, while the marketers of the product are laughing all the way to the bank. This current situation is a case of the lending companies "creating a market" that shouldn't have been created.* And in this case, there are some "just desserts" being dished out in the form of crashed stock, some ethics investigations and maybe even some criminal prosecutions.

(*Note: I'm not saying that lending companies created the demand here. There is always a demand for free money or easy credit. Lenders created the supply, and thus created the market. You could set up a business to lend million-dollar unsecured loans with no credit checks, and I'll bet you'll find pent-up, currently-unsatisfied demand from several billion people -- but obviously it would be a bad business decision to enter that market. All of this comparison to Pet Rocks and the like is just to connect the two different shady kinds of business. In the Senate hearings on this fiasco, I bet we will hear time and time again from lending execs that they were just "trying to meet the market demand for this kind of loan product." And guess what? I just did a Google search for lender trying to meet market demand. The first result was (I admit, this amuses the hell out of me) a recent speech by Sen. Hillary Clinton:

According to most recent statistics, delinquent payments now affect more than 13 percent of subprime loans in our country. That's the highest level in four years. Now, many would attribute this rise to unsophisticated homebuyers, even irresponsible buyers, or the subprime market itself. But the foreclosure rate for all mortgages increased by more than 17 percent in the last quarter of 2006. That's the highest foreclosure rate in four decades.

So when somebody tells you this subprime market thing is no big deal, or maybe, you know what, let the buyer beware, these folks signed on the dotted line, it's their responsibility. Ask them why the rate for all homeowners is so high. Because the economy is not supporting homeownership the way we need it to. And after all, in the absence of an alternative, the subprime market has opened the doors to millions of families and responsible lenders and the market are rightfully casting out some of the worst actors in the subprime industry. But the market will not address the millions of families trapped in unworkable mortgages, hounded by delinquency and facing the grim possibility of foreclosure.

...

We need to expand the role of the FHA to issue more mortgages at better rates to these homeowners. We need to give consumers more counseling and information, prevent families from being trapped in high interest loans with pre-payment penalties and in some cases, allow more breathing room from foreclosure.

...

Now, I will soon be reintroducing my 21st Century Housing Act, which will take steps to modernize the agency by allowing the FHA to reinvest a portion of its revenues in new employees and information technology; to develop new mortgages to meet market demand and to position the FHA to work more efficiently with lenders and to serve more borrowers.

Guess what, JLP? It's neither the lenders' nor the borrowers' fault! It's the economy's fault, stupid! Ok, that was a bit longer diversion than I meant to take, but I was just so amused by that.)

Tech blogger and Yahoo Jeremy Zawodny blogged a couple of weeks ago about New Century Financial Corporation's website and the dangers of having a live stock quote on your company's homepage. I'm sure the slide from $30 to less than $2 in two months is something that NCFC really wants to promote on their front page! (And I'm really surprised that they haven't taken it down yet). That stock is no longer listed on the NYSE.

Are the individuals responsible for their own individual problems? Of course. But they're basically too stupid to keep themselves from getting into these problems. That's an assumption you can always bank on (pun intended). "Nobody ever went bankrupt underestimating the intelligence of the American public." This is pure statistics, and (as I have written before) it is the thing that has driven the success of Dave Ramsey's philosophy more than anything else: you simply can't trust the majority of people to make good decisions about money. People are short-sighted. The story of Faust is resonant for a reason.

I read stories like this one and I find it hard to place the blame in any particular place. First off, the people sound like idiots because they knew they were signing for a more expensive mortgage than they wanted. Secondly, the real estate agent sounds like a scumbag. Thirdly, the loan originators sound just as stupid as the borrowers for lending to people skating so close to the edge, without requiring enough equity to be able to withstand a hit if the local housing market dropped. The kind of loan that these people got (100% financing) sounds like the kind of loan I'd only give to somebody with A to A+ credit. And then there's Wall Street, which seems to gobble up mortgages like there's no tomorrow. I've actually read (and thought it was reasonable) several authors writing about investing in REITs (Real Estate Investment Trusts) because they produce a good rate of return and their loans are backed by actual assets. Well, New Century Financial Corp. was an REIT. There are undoubtedly some good (non-subprime) REITs out there, but this whole thing leaves a bad taste in my mouth. Also, the "backed by assets" promise doesn't seem so great any more.

There's also the matter of subprime loan recipients. Think about it: if you're applying for this kind of loan, you're already desperate. Your credit sucks. Do you really care that much about a foreclosure if you're already so badly off to begin with? At that point, taking on a mortgage is just a gamble, and you probably realize it. You think "Well, I know I probably won't be able to make my payments for the next 5 years, but I'll just enjoy the house while I have the chance." So you're sitting there, you found a house and this guy is telling you that you can qualify for a loan. The terms are ridiculous, but who cares? You'll be no worse off than you currently are if you default on the loan. And if you happen to keep a good job and pay off the loan eventually, hey, great. It's other people's money anyway, right? And there's never been a better opportunity for these people (in terms of interest rates and the housing market) than there was two years ago. Is it any wonder? Can you really blame these people for taking out these mortgages? They took a risk, sure, but it really wasn't terribly risky for them. They weren't even going to lose their down payment, because they didn't make one.

Anyway, I'm just rambling now. My main point: Everybody has their share of the blame. Individual borrowers: to blame for their individual loans, taking out too much in loans, not reading or understanding the loan documents properly. But we're talking about millions of individuals here. On the corporate side, we're talking what, maybe a hundred (order of magnitude) companies all originating these loans? Shouldn't these companies with billions of dollars at their disposal have been more prudent than the unwashed, credit-less masses? (I do realize that I'm probably giving too much credit to these corporations.) Moving on upward through the chain, I have a pretty hard time blaming the government at this point, although the government will be to blame if it bails out any of these bankrupt companies or encourages any more of this kind of loan. On principle, I'll rarely argue for more regulation, and if the further regulation goes the way that Senator Clinton is proposing, it will just make things worse.

A Question and an Example

First off, the example: golbguru has documented the effect of credit utilization (what I usually call debt (or balance) to credit ratio) on his FICO score. To sum up, his score went from 771 to 737 when his credit utilization went from 2% to 23%. He did this as part of a credit card arbitrage plan.

This is the kind of thing I love to see. I am just one person with one FICO score. I have tracked my score for about 3 years now, and I have seen the effects of various financial decisions on it. But I necessarily have a limited set of experience there. Seeing how other people's FICO scores change in certain situations is more data that helps up to confirm our model of the FICO score and how to properly game it. If any other readers have similar experiences (with before-and-after FICO scores) to share, I would love to have you leave a comment about it!

Now, on to the question part. A reader wrote in recently with a question about student loans for an MBA student. I am doing some research for the full answer, which I will post here soon; part of this research involves getting info from others. Namely, have you (or somebody you know) ever been turned down for a student loan? What kinds of student loans, e.g. Stafford, Perkins, etc.? For what purpose were the loans, e.g. undergrad, grad school, med schoool, law school, business school?

When I went to college, I got Stafford and Perkins loans. My parents also got PLUS loans for my education, even though their credit was in pretty bad shape at the time. I was (and still am) under the impression that it is very difficult if not impossible to be turned down for these loans; I'm not sure if your FICO score ever even enters the equation. Student loans are heavily regulated and sometimes even backed by the federal government. Plus, they seem like a pretty safe loan. Education is a proven good investment, and after graduation, one's income is almost guaranteed to go up. Plus, student loans can't be wiped out by bankruptcy.

But, my knowledge is once again limited to my own experience. I have no idea what the loans are like for graduate school or professional school. So I am asking you to please leave a comment so I can find out more. If you have ever had student loans, I want to know about them.

Risk, Freedom, Security, and the Majority

Over at All Financial Matters, JLP has made a couple of heavily-commented posts about paying off a mortgage early vs. letting it run for its full term. (If you haven't read these posts along with all the comments, please do so! A lot of what I'm going to say relies on the context from those comments.) This is another thing that Dave Ramsey harps upon, and his followers also feel strongly about it.

I have been reading a book by Robert Kiyosaki (hear me out here) called Rich Dad's Prophecy. I borrowed it from the library, and I am not yet done with it (actually I'm only about a quarter of the way through it). I guess I will get more into Kiyosaki on a later entry, although I'll note now that I generally "drink the Kiyosaki Kool-Aid." I can't yet comment too much on this particular book, as I'm not too far into it and he seems to be making more claims than he generally does.

At the point in the book where I stopped last night, RK spends a lot of time talking about freedom vs. security. A lot of time. He can be very repetitive, although I can't really begrudge him that. Some ideas just need to be hammered away. Anyway, most of the discussion is couched in terms of retirement accounts and how most people are counting on their retirement to be secure (like the old-style defined-benefit pension plans) while they are actually nowadays more free and hence less secure (401(k)s etc. are usually invested in the stock market, leaving more choice to the individual holder, but the stock market has its inherent risks). If the supposed Social Security Reform ever goes through, this trend will just continue.

It is very clear that the majority of people will opt for security over freedom, both in the political arena and in the realm of finances. Most people are not risk-takers. They want their money invested safely. That is why they want to do things like pay off their mortgages early. And this is where I am slowly coming around to Dave Ramsey's point of view on certain things. The majority of people cannot be trusted (and cannot trust themselves) with absolute freedom. It is all too easy to ruin your life and run your finances into the ground. So many people do it all the time. So I can see why DR needs to be dogmatic about it and basically force people into having security by locking themselves into a 15-year mortgage, even though they lose the flexibility to do something else with that money.

But, there are people who have self-restraint, live well below their means, and save a lot of money without being forced to do so. I believe myself to be one of them... we'll see in 10 years where it's gotten me.

Follow-up to earlier posts

I got the following questions from sm in response to Part V of the Intro to Credit Gaming series, which covered credit inquiries and new credit:

Do you know a general rule of thumb for how long one should wait between applying for credit cards? How many credit applications is OK per year? Also, does pulling your own FICO score show up as a credit inquiry?

Sorry it took so long to reply -- somehow this comment slipped through the cracks (I wish that Blogger had a "new comment" notification!). As a rule of thumb, I typically don't apply for new credit within 6 months of receiving other new credit. However, this rule was made to be broken. I would try to wait 6 months between credit cards. However, mortgage and auto loans are handled differently.

MyFICO.com (please use that link if you want to use MyFICO to buy credit scores) has a fairly comprehensive page on credit inquiries. In particular,

For many people, one additional credit inquiry (voluntary and initiated by an application for credit) may not affect their FICO score at all. For others, one additional inquiry would take less than 5 points off their FICO score.

Inquiries can have a greater impact, however, if you have few accounts or a short credit history. Large numbers of inquiries also mean greater risk: People with six inquiries or more on their credit reports are eight times more likely to declare bankruptcy than people with no inquiries on their reports.

So for most people, inquiries will have an extremely minimal effect on your credit score. As long as you have a good credit history and lots of credit to begin with, inquiries will barely affect your score. If you are just starting out and have no history or established credit, your score will be affected more. This also answers another question: try not to have more than 4 or 5 inquiries in a year if at all possible. Inquiries stay on your report for 2 years, but they only affect your score for 1 year. This is why I recommend that young people starting out with their credit limit their credit card applications to one every 6 months. Of course, if you don't have a mortgage application or other big credit need coming up within the next 12 months, you can choose to go wild with the credit apps and everything will disappear from your score when those 12 months are up.

This connects to a discussion between golbguru and me in the comments of an entry at The Tao of Making Money, which I also wanted to touch on in this post. A little further down on the MyFICO.com page is this:

Looking for a mortgage or an auto loan may cause multiple lenders to request your credit report, even though youre only looking for one loan. To compensate for this, the score ignores all mortgage and auto inquiries made in the 30 days prior to scoring. So if you find a loan within 30 days, the inquiries won't affect your score while you're rate shopping. In addition, the score looks on your credit report for auto or mortgage inquiries older than 30 days. If it finds some, it counts all those inquiries that fall in a typical shopping period as just one inquiry when determining your score. For FICO scores calculated from older versions of the scoring formula, this shopping period is any 14 day span. For FICO scores calculated from the newest versions of the scoring formula, this shopping period is any 45 day span. Each lender chooses which version of the FICO scoring formula it wants the credit reporting agency to use to calculate your FICO score.

Ok, that's a big chunk of text. Let's look at exactly what it says, because although it's all connected, there are two main points here.

1) While you're shopping for an auto loan or mortgage: None of your recent (within 30 days) auto loan or mortgage inquiries will show impact your credit score. You can go to 4 different lenders, each a week apart, and your inquiry with the first lender will not affect the score that the 4th lender sees. This is plenty of time to find a mortgage or auto loan. Note that this only pertains to these particular kinds of loans. Recent credit-card inquiries will still show up and affect your score.

2) After you're done shopping for an auto loan or mortgage: All auto-loan or mortgage inquiries within a 14- or 45-day span (depending on what scoring method the lender uses) will be consolidated into 1 inquiry for the purpose of your credit score. So you could shop around at 20 different lenders for your mortgage, and have all of them pull your credit score with a "hard" inquiry, and it will show up as 1 inquiry on your score after you're done shopping. Obviously you should try to limit your shopping periods to 14 days, because you have no way of knowing which method any future lender will use.

And finally, to answer sm's last question, no, checking your own credit score does not result in a "hard" inquiry that will show up on your credit score.

And finally-finally, I wanted to clarify about the Washington Mutual credit card that I use to keep track of my credit score. It is not an annual free trial or anything like that. As long as I have the card, I will be able to log in to the site and check my credit score. I assume that this is actually a near-costless benefit for WaMu because, as a lender with which I have an open account, they are checking my credit score for their internal purposes on a regular basis anyway. All that they have to do is take that score (which they're already pulling) and put it up on the website. It is accessed through the account management website, as just another part of the site. There's the typical "View Statement", "Pay Bill", etc. and then there's the "Credit Profile" page. If anybody wants me to create a post with screenshots, etc. then I will be happy to.

Why I Disagree with Dave Ramsey

The other day, I was driving a lot and happened to catch a couple hours of Dave Ramsey's show. I think I've got a bit better read on him, and I know now that I disagree with him on a super-fundamental point.

Some chick called in from Houston talking about how she had been in a lot of credit card debt, but she pulled herself out of it and was now using them responsibly, turning the tables on the credit card companies by putting them to use instead of the other way around (as I advocate). Well, Dave Ramsey would have none of it. He gave the oft-cited statistic that people spend 15% more when they have a credit card than they do when they pay cash. He cited a study by McDonald's that said that people spend more with credit cards than with cash.

(Brief aside: I couldn't find anything specific about the way these studies were conducted, but really quickly I can come up with a way that they might be flawed: Cash is obviously limited. People who carry both cash and credit cards might try to pay with cash but be forced to pay with the credit card when the transaction size gets too large. Also, I think that many people (like myself) are reluctant to use the credit card when it's just a small transaction amount. So you have to turn the question around: what if, instead of credit cards "making" people have larger transactions, having larger transactions "makes" people use credit cards? This is an easy way to get the same result. As everybody learns in Statistics 101, Correlation Does Not Imply Causation. And even if it does, the direction of the causation is often up in the air. If anybody's got a link or further info on any of these studies, please let me know! There's got to be a journal article somewhere.)

Dave said that he had an "emotional attachment to cash" (and implied that everyone else in the world does too). He said something to the effect of "when you pull out old Uncle Benjamin and lay him down on the table to pay for a meal, you have a little heart-to-heart." This is absolutely false for me. I have never been too good at holding on to cash. To me, cash is meant to be spent. If I didn't want to spend it, it wouldn't be in my wallet, or even in the form of cash at all. It'd be in the bank. Some people talk about credit cards as a contrast to "money in the bank" (e.g., when distinguishing between credit and debit cards and why they prefer the latter). In my case, cash is "money already out of the bank."

When I lay down the credit card, I know that I'm still going to have to pay for it when the statement comes. Using a credit card obliges me to carry out a future action. This adds certain weight on the mind. Cash has no such consequence, and carries no such weight. In fact, when I use cash, I get the opposite emotional effect from what Dave describes. I feel carefree. Sometimes (if the amount is large) I even feel powerful. Spending cash gives me a high, even if it's just $5 at the sandwich shop. Spending on credit gives me the opposite effect. It is literally a burden, and it is felt as such. This is one thing that helps me keep from over-spending on my credit cards.

Insurance: Never a Good Deal

Insurance. It's one of those things that most of us just see as necessary. In fact, in many cases, carrying sufficient insurance is mandated by law. You can't legally drive a vehicle without insurance, and I think that most of us would agree that it would be stupid to do so, regardless of the law. A single car accident could easily cost in the hundreds of thousands of dollars after property damage and medical care are taken into account. Most of us can't afford to pay hundreds of thousands of dollars on the off chance that such an accident occurs, so we pay our monthly premiums for a service that we rarely, if ever, use.

Insurance is one of those things where we consumers really don't have a whole lot of choice. Insurance companies are VERY good at being profitable, which is to say, taking in more money than they pay out; in other words, over-charging the customer to a large degree. If those profit margins start to slip, they can just raise the premiums. You don't have to be a rocket scientist to make big profits in the insurance industry, but they've got rocket scientist actuaries working there anyway.

Anyway, all of this is to say that the formula used by all insurance companies is like this:

(Sum of all money you pay to the company) < (Sum of all money you receive from the company)

Which in itself is just a complicated way of saying that insurance is never a good deal. At its basic level, you are not paying for a product or service from an insurance company. You are paying for money (actually, the chance at some money). Pure and simple. Yes, there is a bit of service involved, but this is pretty minimal.

In many ways, insurance is like the lottery. You buy a ticket for $1. So do a whole bunch of other people. Then the lottery pays one person a whole lot of money, and a few other people smaller amounts of money.... and most of the people end up with $0. But they still keep pumping their money into the lotto, because there's always that chance that they'll win.

In fact, at least the lotto has something positive for it. People play the lotto because they want to win. People buy insurance because they don't want to lose. At root, insurance is the industry of fear. "How afraid are you of losing $100,000? That's okay, just pay us $X per month and we'll make sure you never lose that $100,000. Only we've looked at the statistics and cooked the numbers so that we'll take in 3 times more than we ever have to pay out."

But of course, we all have fears, and it feels good to put them at ease. Also, bad things DO happen, or else insurance companies wouldn't be around at all. So it makes sense to have at least some sort of insurance. But you have to look at it from a rational, economic perspective.

In a recent post, Foobarista wrote about "cashflow preservation insurance" versus "wealth preservation insurance". I had never heard of this differentiation before, but it struck an immediate chord with me since a similar idea had been developing in my head for a long time (basically my idea was "certain kinds of insurance are a rip-off, but others make sense." I never had a rubric for separating the two other than my gut reaction).

o Wealth preservation insurance. This is a hedge against big, unknown expenses like getting sued or enormous medical bills.
o Cashflow preservation insurance. This is a hedge against "bump in the road" issues like car repairs or replacement of electronics or appliances.

Once it's put into such simple terms, it's easy to see what kind of insurance you should and shouldn't buy. "Wealth preservation" insurance: buy. "Cashflow preservation" insurance: don't buy. So do buy catastrophic medical insurance, malpractice insurance, auto liability insurance, landlord insurance. Don't buy comprehensive auto insurance, renter's insurance, extended warranties of any kind, etc. Things like homeowner's insurance (or maybe auto insurance for a really expensive car) sort of fall in between: get them, but with very high deductibles.

But again, insurance is never a good deal, even the "wealth preservation" kind. The game is still set up to take more money from you than it will ever give back. Really, the demarcation line between cashflow and wealth preservation insurance is simply a matter of your cashflow itself. As you get richer, you can afford to self-insure more and more of your things. For example, if you own 20 rental houses, you have much less need to insure them because you can afford to take a complete loss if one of them burns down (assuming that they're not all located right next to each other!). But if you own just one rental house, it represents a large part of your holdings, and you would be financially devastated by its loss. If your cashflow (aka disposable income) is $2000 a month, you are probably not going to want to insure your car with a $200 deductible. On the other hand, if you usually find yourself with $100 left over at the end of the month, a $200 deductible might seem reasonable.

Sorry for the long delay between posts. And sorry for the somewhat off-topic nature of this post. I'm really finding myself scratching my head to come up with more credit-related topics. I'm welcome to any suggestions. I don't mind covering more general personal-finance topics, but I would like to try to keep up the credit posts, if at all possible. But to be honest, from the beginning, I really saw this as more like a book than a blog. I only know so much about credit scores. I just wanted to take my knowledge and put it out there as sort of a reference. I really don't feel like repeating myself or beating a dead horse just to come up with new posts. So, readers, I ask you: what do you want to see out of this blog in the future?

Credit Cards for People without SS numbers?

Unbelievable, but that's what Bank of America is going to offer soon. I'll refrain from getting into a political discussion here, but I'll just cite this as more evidence that banks are bending over backwards to give people credit. Whether it's a pre-paid credit card, a bank line of credit, or what have you, there is always a way to get credit if you don't already have it.

Yes, it is possible to have credit ruin your life. But fundamentally, that is your choice; you ruin your own life through credit. You can't blame a credit card company or anybody else if you run up a boatload of debt. It isn't hard to take personal responsibility and manage your credit successfully. If you do, you can profit in many ways. From gift certificates to airline miles to lower interest rates on your mortgage. You can work within the system and work it to your benefit. It just takes a little self-discipline and getting over your fears about money.

If you don't have a credit history, get started now. I'm not the only one saying so; there is a new blog out there called CreditPro, run by a professional credit counselor. To my chagrin, the topics are pretty similar to what I've covered here, yet it seems to be much more popular (69 comments on one entry!) despite only being around for about a week. Anyway, enough jealousy; the CreditPro blogger seems to be pretty good, so if you read my blog, you should check out that one too.

Easy First Credit Source: Checking Overdraft Protection

This is a quickie tip that I've mentioned in passing before.

If you're young and credit-less, getting your first credit card may be difficult. One alternative is to get a line of credit at your bank. Usually this will be called something like "Overdraft Protection" or "Checking Plus". This is usually just a $500 or $1000 line of credit that is linked to your checking account; it should go unused, assuming that you manage your checkbook properly. But it should, in most cases, also go on your credit report as a revolving line of credit. The banks that I've had have put it on the credit report; some banks might not, so ask to be sure! If you've got a checking account in good standing, it should be pretty easy to get this.

Remember, Establish credit - now!

A Simple Life Hack: Sort Coins in your Car

If you're like me, you accumulate spare change. I don't get a whole lot of it, but it's enough to overwhelm the little coin-holder tray in my car a couple of times a year. Once it gets full enough that the coins slosh out onto the floor when I take a corner too hard, I know it's time to clean it out.

Mentally, I sort change into two categories: useful (quarters) and non-useful (dimes, nickels, and pennies). (Other pieces such as the half-dollar or dollar coins are sufficiently rare in my life that I usually just put them aside as a curiosity until they can be spent.) Quarters can be used at the laundromat, to pay the toll on toll roads, in vending machines, etc. The rest of it is pretty much useless to me. I usually don't have the time to count out a bunch of coins to pay for something. It's good to have a few nickels and dimes on hand for the odd stuff at the vending machine, but no more than that.

So I periodically go through and sort the quarters from the non-quarters. I happened upon a trick that makes this job very easy to do, even while driving. Your standard plastic drink bottle (I used a 1-liter water bottle; a soda bottle would work just as well, but you'd want to wash it out) has a mouth that is smaller than a quarter but will accommodate any other common U.S. coinage. My procedure is to set the empty (and well-dried-out) bottle between my legs while driving down the highway, and use my right hand (the left stays on the steering wheel) to grab small handfuls of change from the tray, and use my fingers to guide the coins into the mouth of the bottle. Since quarters don't fit, they are easy to sort and put into my special quarter space (inside the center console). The rest of the change lives in the bottle, which I usually keep under the front seat (with the lid on) until it's needed again. Occasionally I'll empty out the bottle and take the coins to my bank. Note: the coins don't come out the mouth of the bottle very easily, so I'd suggest that you simply cut open the bottom of the bottle.

When I'm driving, it's not like my brain doesn't have a little extra processing power that it could put towards something else, but such things are usually pretty unsafe (e.g. I refuse to read while driving, unlike some people I know). This task requires just one hand and does not require you to take your eyes off the road for any appreciable length of time. You can do the whole thing mostly by feel, and once you're done, your coins are sorted and your change tray is clean.

If you like to sort your coins for rolling, you could even take it a step further and use 3 separate bottles (still enough to fit between your legs or maybe squeezed in next to the seat) and use your fingers to feel the difference between the coins and put them into the correct bottle. Obviously this would go much more slowly (as each coin would need to be handled individually), but if you drive a lot, it shouldn't be too onerous.

Credit Score and Payment/Balance Timing

Given that your credit score depends highly on your balance to limit ratio, you will want to do some planning before applying for something big like a mortgage or a car loan (although I recommend against getting car loans). In particular, if you do as I do and put most of your purchases on credit cards that you pay off monthly, you will probably want to stop this behavior for a month or two leading up to the mortgage application. This is because of timing issues with your credit report.

First off, companies are always on a delay when it comes to reporting your credit status. When I last looked at my credit report in late January, the status of most of my accounts was current through December. But a couple of my lenders (a couple of credit cards and both of my student loans) were current only through November. These accounts showed the balances from November. So if you want to show 0 balances on your credit report (and thus your credit/limit ratio would be 0, bumping up your score) you would be best advised not to use your credit cards at all for 2 months leading up to your loan application.

Here is a listing of my credit scores for the past year (this tracking of scores up to a year is one of the benefits of my Wamu Card):

Feb 06 731
Mar 06 746
Apr 06 766
May 06 765
Jun 06 772
Jul 06 748
Aug 06 720
Sep 06 760
Oct 06 743
Nov 06 772
Dec 06 766
Jan 07 764

You can see that there's considerable variation. I can't remember what was going on in February, and in August I put an extra $4000 on one of my cards. (It was paid off within 2 months.) But for all other months, the combined balance on my credit cards was always around $3000 (always paid off monthly). I really don't know the reason for most of this variation, so I attribute it to the vagaries of timing. Eliminating all of my credit card usage would probably lead to a much more stable (and slightly higher) credit score. I may start such an experiment soon. If I do, I will be sure to report the results here.

How I Keep Track of my Credit Score

I have a credit card with Washington Mutual (aka WaMu, formerly Providian) which provides a free monthly credit score. I have not charged anything to the card in about a year now. I use it solely for the free credit score, which I find very handy. The card itself sits at home... somewhere (not sure where.... just went through a move).

It seems as though the credit score is updated at the first of the month, but it is not available on the website until the 20th or so. I am not sure how accurate that first date is. The site says "Updated on: 12/01/2006", but it seems strange to me that the score is pulled on the 1st but I can't access it until the 20th.

In any case, despite the question about the timing of the updates, the service is extremely handy. It shows everything from one reporting agency (in my experience, it has always been TransUnion, although evidently it can be Experian as well). I know that all 3 FICO scores track together, from the couple of times I have checked all 3. As long as I check my credit reports (not credit scores) regularly to make sure that there's no bad info on any of them, I am content just using the Washington Mutual service to check my credit score rather than something else.

I've had my Providian/WaMu card since 2003, which has allowed me to track my FICO through quite a few changes. The biggest monthly rise was when I got a new credit card with a $10k limit (at the time, more than all my other card limits combined) and transferring my balances (which were all skating close to the limits) to that card. Since then, I have paid off that card and never run up a balance on any of my cards.

If you want to sign up for a Washington Mutual card to get this benefit, the website is WaMuCards.com. If not, the best place to get your FICO scores is through MyFICO.com . If you decide to use MyFICO, please use that link, as I just signed up to be part of their referrer network and will get a commission based on whatever you buy. The Google ads aren't getting many clicks (not so surprising) so hopefully this will work better.

What's Not On Your Credit Score: Income

When applying for any type of loan or credit, you will have to include your income. Something to keep in mind is that your income will never go "on your credit report" or affect your credit score. You can have a very high credit score and low income, or high income and a very low credit score. The two are mostly independent (although it's probably easier to take the actions necessary to get a high credit score, i.e. minimizing your debts, if you have a high income).

But your income can feel like it's part of your credit score when you're applying for a loan. Sometimes it can be a bigger determinant of the outcome than your credit score! Even if you have a really poor credit score, if you've got a sky-high income and you can document that income, you will be able to get some kind of loan (although it will be at a high interest rate). Conversely, if you have a great credit score and a low income, most lenders will find it quite easy to turn you down.

This gets more important when applying for mortgages. Most mortgage lenders will require you to document your income. They might require anything from check stubs to your tax returns for the past 2 years. However, if your credit score is high enough, you can get a no-documentation loan, aka a "stated income" loan.

I was fairly amazed (and grew to appreciate the value of a good credit score) when I was thinking about buying a rental property last year. I walked in to the bank (a very large, national bank... you've definitely heard of it) and the mortgage guy checked my credit score. This bank used the median score out of the three; since my median score was above 750, I was pre-approved for more than twice what I was thinking of spending with a 5% down payment and no income documentation. In the words of the banker, "If your credit score's that high, we'll believe you when you tell us what your income is." That statement made my jaw drop.

Of course I told him my correct income, but since I'm an independent contractor who's reimbursed for lots of stuff, my "income" is unusually flexible. If you looked at the checks I get every 2 weeks, you'd say my income is X; if you looked at my final net income on my tax returns, you'd say my income is more like 0.6*X or maybe even X/2. A more realistic view would say that my "income" (as most people would figure it) is about 0.8*X. On a stated-income loan, I'm able to use this more realistic figure rather than the understated income on my tax return.

I am not suggesting that you lie on a loan application, and I'm not saying that I've done so or are even thinking of doing so. I think that would be very dangerous. But, at the same time, I appreciate the flexibility that I now have when it comes to mortgages. The whole process becomes much easier. I get to skip a bunch of forms and paperwork that I would normally have to fill out. I get to give the bank a more realistic (yes, higher) view of my income. And I wouldn't be able to have this flexibility without an awesome credit score. And I'm happy to tell you how to achieve that.

AnnualCreditReport.com Timing Issues

As you probably know, you can get a free credit report yearly at AnnualCreditReport.com. This is mandated by the federal government. You can get one per year per each of the 3 credit agencies.

Note the ambiguity in that last statement: one per year. A reasonable interpretation of this is one per calendar year; i.e., one in 2005, one in 2006, one in 2007. I thought that this would be the case because of the way they rolled out the free reports across the country in 4 phases; the first 6 months, only the Eastern part of the country could receive their reports, then it expanded from there. I can't remember the exact rollout plan, but it doesn't matter. The point is that there were set dates when you could get your reports, according to where you lived in the US. Somehow this led me to believe that the "annual" thing was based on the calendar year.

But noooo. They apparently mean that there must be a year between each credit report. Since I didn't really need it in 2006, I purposely waited till the end of the year to obtain my free reports, thinking that I could get them in 2007 whenever I wanted. But I recently tried to pull my TransUnion report through AnnualCreditReport.com; due to a minor issue, I wanted to see if something had come up as a new inquiry. However, it wouldn't let me. It said that I already had obtained my report. I last pulled my TransUnion report in November of last year.

So clearly they aren't basing it on calendar year. I assume (will have to wait until November to find out for sure) that they are basing it on the amount of time from one report to the next. So, the take-home lesson here is that your free "Annual" credit reports are only "annual" if you get them at the same time every year. By waiting longer between free credit reports, you are putting off the earliest time when you can get your next free credit report. Your "year" resets each time you get the free reports.

Hope that helps somebody.

Intro to Credit Gaming - Part V

See previous parts I, II, III, IV.

We finally get to the last component of your credit score, "recent credit requests and recently obtained credit", which comprises 10% of your credit score. This is the one that many people seem to freak out about. "I don't want to apply for X, because I don't want the inquiry on my credit report!" is the common refrain heard on forums and weblogs everywhere. The thing to realize is that 1) you have to have quite a few inquiries in a short amount of time for this to have any impact; and 2) even so, the impact will be quite minor, as well as short-lived.

First off, let's examine the reasoning behind this component of your credit score. The first part is "recent credit requests." Say that you have applied for 7 credit cards in the past 3 days. That will be enough to cause any lender to worry. First off is, even if your credit is otherwise good, why would you be applying for so much credit in such a short time period? Maybe your finances are in disarray, or maybe you've gone crazy. In any case, it's a red flag. If you're denied this new credit, that's a knock against you. Moving along to the "recently obtained credit" part, if you're approved, that's also a problem because now you have a new line of credit which you have not proven yourself able to use responsibly.

So that's the negative part. The positive part is that any normal behavior will hardly ever be punished, and any punishment will be very limited. The max that your score can be decreased for this purpose is 50 points. That can be enough to make a difference in interest rates for a mortgage, but it's not enough to make "good" credit look "bad." According to the MyFICO site, inquiries can affect your score for up to 12 months, but they seem to stay on your report for longer (I've got some that are 23 months old on my credit report).

Another positive thing is that, assuming your application is approved, chances are that your credit score will go up overall instead of down. This is especially true with credit cards or other revolving lines of credit. Adding a new line of credit will increase your overall credit limit, which will decrease your debt to limit ratio, the second most important part of your score. I guess that obtaining a new installment loan (such as a mortgage or auto loan) will probably decrease your score overall; you'll have first the inquiry, and then a bunch of new debt added to your report. However, I'm not sure how much of an impact this would actually have on your FICO score. I'm lacking data here.

Basically, my point here is that you really shouldn't worry about this aspect of your credit score too much. If you know that you are going to be applying for a mortgage very soon, you should probably not apply for any other credit if you can help it. Checking your credit score and talking to your lender will help you find out if you might be close to the line between two interest rates or loan package programs. If so, a couple of points could make the difference, and these particular couple of points are easily managed. Otherwise, though, don't worry about it. The natural variation in your credit score (due to timing issues when lenders report to the credit agency, etc.) will probably be quite a bit larger than the tiny amounts you might get docked for recent inquiries.

The Penny Problem

Rising metal prices have caused pennies and nickels to be worth more as scrap metal than their face value. Therefore, the US Mint has banned melting of pennies and nickels. And now, Fed Economist François Velde is recommending that the penny be "re-based" to become a 5-cent piece. You can read the original 4-page document here (PDF, and worth the read). While this sounds crazy, it's actually pretty much the only choice that the government has. History has proved this time and time again.

I happened to have Mr. Velde as a professor in college. He taught a course on monetary history (I got a B+). It was my favorite Econ class. His book The Big Problem of Small Change is both well-written and informative. It goes in some depth through the history of money, mostly focusing on the problems of medieval currency and into the modern day notion of fiat money (money with no inherent value... which is the source of the penny problem, since coins always have some inherent value). If it sounds crazy to you to simply decree that pennies are now worth 5 cents, you need to read this book. The same thing happened numerous times in various European countries from the 1500's forward.

Spain (actually, Castile) was especially good at this. The problem with using gold and silver coins is that both gold and silver are commodities with their own values that fluctuate according to market forces. This was a problem in 17th Century Europe, and especially Spain, due to the huge fluctuations in value as a result of precious metal discoveries in the New World. If I recall correctly (I wish I had the book in front of me), gold and silver were originally relatively similar in value (compared to today). With the huge amounts of silver found in Central and South America (note: Argentina gets its name from "argentum," the Latin word for silver), silver began to fall in value relative to gold.

The Spanish government was forced to revalue its coins. It basically ran a campaign to turn 10-unit coins into 20-unit coins. Citizens would bring in two 10-unit coins, the government gave them a "new" 20-unit coin (really just a restamped 10-unit coin) and kept the 2 old 10-unit coins. So the government would get 1 coin for free, while the citizens would keep the same amount of "money."

It sounds kind of stupid, but the amazing thing is that it worked. The Spanish government did this many times in the early 1600's. Most other European governments had to do the same thing during this general time period. I wish that I could give more detail (and hopefully I'm right on the detail that I did provide) -- the book is packed away somewhere, and there's no way I could find it right now. It has been years since I've read the book, and more years since I was in his class. So my memory is fuzzy, but I'm pretty sure I'm right. The book also goes into the theory of the whole topic, putting everything into equations, so we could figure out in our scenario above exactly how low silver could sink relative to gold before people started melting their gold coins. If you want to get into the nitty-gritty, have a look at Mr. Velde's working paper selections. The most historically-minded (and least mathematically dense) paper is The Evolution of Small Change, where you can find a discussion of the Spanish "experiments" (in which the government of Castile came very close to implementing a virtual fiat money policy) on pages 40-45.

If you still think this whole thing is stupid and would never work in real life, just think about the current situation. What if the US Government announced tomorrow that it was doing away with the penny? The program would be very similar to what the Spaniards did. You would bring 5 pennies in to a bank, and the bank would give you a 5-cent piece back. This new 5-cent piece would be about the same size and metal content of a current penny; current nickels would also be traded in for the new 5-cent pieces. Given the high transaction rates of our currency, it would not take long for pennies to disappear completely; some would be hoarded, but most would be traded in. Banks would collect them just like they collect worn-out dollar bills to send to the government to be destroyed. The old nickels and pennies would be collected, melted down, and minted into the new 5-cent pieces.

My bet is that most of the American public would welcome the change (no pun intended!). I have friends who have groused about pennies for years now. Yes, there are a few who would hoard the old coinage, but most people would be happy about the convenience of one less coin to deal with. Mr. Velde's suggestion is similar to this, but it saves the cost of having to re-mint everything and take the old pennies and nickels out of circulation. While this would be basically the equivalent of what I outlined above, I think there would be quite a bit more resistance. After all, a penny says "One Cent" on its reverse. Decreeing all pennies to be worth 5 cents would be a bit too much cognitive dissonance, I think.