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The Basics Anatomy of a credit score Merchants, landlords, employers, lenders and even insurers check credit ratings. Here are 4 score-polishing tips and ways to avoid dinging your numbers. By BusinessWeek During a shopping spree a few months ago, I opened several retail credit-card accounts to take advantage of an immediate 10% discount on that day's purchases. Surely this familiar offer was risk-free as long as I paid my bills on time, right? It wasn't until I reported this story that I found out my credit score could have been negatively affected by the spate of new accounts I opened in such a short time. I had no idea. Many people are ignorant of what their credit score is, how they can hurt or help that score and how it can be used against them. Some 49% of 1,013 consumers polled in a 2005 survey by the Consumer Federation of America and Fair Isaac did not understand that credit scores measure credit risk. Fair Isaac created FICO, the most widely used credit-score formula. Lenders have used these scores for years to determine whether to grant you a loan and at what interest rate. "Credit scores are very powerful predictors of consumers' future (bill-paying) performance," says Mike Fratantoni, a senior research director at the Mortgage Bankers Association. But with the rise of technology that can automatically assess consumer creditworthiness while you wait, FICO scores now are requested by insurance companies, cell-phone providers, utilities, landlords and even prospective employers. That's a reason to make managing your FICO score a priority. Recipe for a credit score But first, just what is a credit score? To calculate a score, Fair Isaac uses 22 pieces of data collected from the three major credit bureaus, Equifax, Experian and TransUnion). The lowest possible score is 300, while the highest is 850. The final number is a composite of individual ratings in five categories: Payment history (35% of the rating) Length of credit history (15%) New credit (10%) Types of credit used (10%) Debt (30%) Income is not a factor. "A person can have a very high income and never pay their bills," explained Craig Watts, public affairs manager for Fair Isaac. Fair Isaac calculates a FICO score based on the data provided by each credit bureau. It's not uncommon to see up to a 50-point differential between ratings. The reason: Bureaus collect data at different times of the month, and one bureau may have inaccurate information. The higher the score, the lower the risk you are to a creditor -- and the less interest you'll pay. Only 13% of the population has FICO scores of 800 or above; the median is 723. There is no single cut-off for loans, however, and cut-offs employed vary from industry to industry. Generally, borrowers with scores above 740 receive the best rates. To see how a change in your FICO score affects how much you'll pay, consider this example. On a $350,000, 30-year fixed mortgage, you'll pay 6.24% in interest and $2,153 a month if you score between 720 and 850. If your score drops to between 620 and 674, your interest rate jumps to 8.05%, and your monthly cost rises to $2,581. You will pay an additional $154,131 over the life of the loan, according to a calculator on myfico.com. Keep an eye on your score Want a peek at your FICO scores? Many people think they can get their FICO scores from their credit reports. They can't -- but it's still a good place to start. The Fair and Accurate Credit Transactions Act of 2003 entitles you to a free credit report from each major credit bureau once a year. I ordered my reports by telephone from annualcreditreport.com and received them all within 10 days. It's smart to request a report from a different agency every four months so you stagger the reports over a year. That way, if there's bad information in one, you'll spot it sooner. When you request a free credit report, each bureau will offer to calculate a credit score for $6.95. Experian and TransUnion use proprietary formulas; Equifax uses FICO scores. Pass up these offers, because the information is not as comprehensive as you'll get elsewhere and lenders are less likely to look at these scores. The Basics Anatomy of a credit score For the most detailed explanations on your FICO scores, go to the credit education area at myfico.com. A score from one credit bureau costs $14.95, all three are $44.85. It's useful to buy all three because large lenders either average the scores or take the middle one. You'll want to check your FICO scores once a year or several months before you apply for a loan. The negative factors that bring your score down remain on your credit report for seven years and can adversely affect your FICO score. But lenders typically look back only in the past two years when they make credit decisions. One 30-day late payment shouldn't make a difference. Lenders look for trends. I paid for three scores and anxiously waited while the computer calculated them on the spot. Within seconds, I was relieved (not to mention a bit proud) when 771, 751, and 738 popped up on my screen. Still, I wondered why I wasn't in the 800-plus range. To find out, I reviewed the various strategies credit experts recommend to raise FICO scores: Pay all bills on time. This is probably the most important factor in the FICO calculation. If you're consistently 30 days overdue, your score can drop by as much as 100 points, depending on how long the account has been open and how long ago the late payment took place. To avoid late payments, consider automating your bill-paying process. I got high marks in this arena. Think twice before closing accounts. Lenders are looking for consumers with long credit histories that have been managed well. But because of the increase in identity theft, you don't want too many open accounts that you don't use. "Be judicious about the accounts you have," says Norm Magnuson, public affairs officer for the Consumer Data Industry Association. In my effort to consolidate our finances, I had canceled an American Express account that Id had for 20 years to become an authorized user on my husband's account. While I benefit from his 20-year credit history on that account, it was a mistake to eliminate my own. I have a few cards in my name only, but the history isn't as long. Minimize credit-card applications. Bingo. That was cited as a problem on all three of my FICO scores. On average, a consumer has a total of 11 credit obligations, of which seven are credit cards and four are loans. I had 21, of which six had balances. Each time you apply for credit, a lender requests to view your report. This inquiry is noted and can reduce your overall score. Don't apply for unnecessary credit. If you're in the market for a big-ticket item that requires a loan, avoid credit applications for 18 months prior to your purchase. Keep balances low. The FICO score evaluates your total balances in relation to your available credit. This is known as credit utilization. Credit cards that are "maxed out" can lower your score. Try to spend only 30% of your credit limit. If you have a $10,000 limit on one card, keep the balance near $3,000. My credit utilization was too high. It helps that I pay off my balances every month, but it is better to spread the spending. While my FICO reports said that "most lenders would consider consumers in this score range as extremely low risk," the competitive spirit in me wants to get over the 800 mark. To that end, I recently refrained from signing up for a Target Stores credit card to get $10 off $100 purchase. 9 ways to build a killer credit score It's much easier to start from scratch than to repair black marks later on. Here's how to push the right buttons at the credit bureaus. By Liz Pulliam Weston Establishing a good credit history has never been as important as it is today. It's not just that you'll need good credit to get decent rates when you're ready to buy a home or a car. Your credit history can determine whether you get a good job, a decent apartment or reasonable rates on insurance. One seemingly minor misstep -- a late payment, maxing out your credit cards, applying for too much credit at once -- can haunt you for years. If you're just starting out, you have a once-in-a-lifetime opportunity to build a credit history the right way. Here's what to do, and what to avoid. Check your credit report You'll first want to see what, if anything, lenders are saying about you. That kind of information is contained in your credit report at each of the three major bureaus: Equifax, Experian and Trans Union. Credit reports are used to create your credit score, the three-digit number lenders typically use to gauge your creditworthiness. Lenders also may look at the report itself, as may the landlords, employers and insurance companies who use credit to evaluate applicants. Can you have a credit report if you've never had credit? Maybe. Somebody else's information could be mixed in with your report, either through a credit bureau mistake or because of identity theft; i.e. someone using your personal information to open bogus accounts. If that's happened to you, you'll need to clean up your credit report before trying to apply for new accounts. The Federal Trade Commission has information that can help. Establish checking and savings accounts Here's a basic step that's sometimes overlooked by people seeking credit. Lenders see these accounts as signs of stability. Opening checking and savings account is also one of the few things you can do as a minor to start building a financial history. While you can't get a credit card in your own name until you're 18 and can be legally held to a contract, many banks have no problem letting you open an account. Many, but not all. If your bank balks, you need to either look around for another bank or consider opening a joint account with an adult. Understand the basics of credit scoring You need to know that the two most important factors in your score are: Whether you pay your bills on time. How much of your available credit you actually use. It's essential that you pay all your bills on time, all the time. Set up automatic payments or reminder systems so that you're never, ever late. All it takes is a single missed payment to trash your credit score -- and it can take seven years for the effects to completely disappear. You also don't want to max out any of your credit cards, or even get close. Keeping your credit use to less than 30% of your credit limits will help you get the best possible credit score -- and should help keep you from getting over your head in debt, as well. Finally, you don't need to carry a balance on a credit card to have a good credit score. Paying your bill off in full is the best way to keep your finances in shape and build your credit at the same time. Piggyback on someone else's good credit The fastest way to establish a credit history can be to "borrow" another's record, either by being added to a credit card as an "authorized" or joint user or by getting someone to co-sign a loan for you. Having a co-signer can allow you to qualify for loans you might not otherwise get. The loan will show up on your credit report and, if you pay it off responsibly, will help boost your credit score. If you default, however, you won't be the only one who suffers. The co-signer has basically promised to make good on this account, so any delinquencies will show up on her credit report as well. Being added as an "authorized user" has its risks, for you as well as the person giving you access to the card. If your father makes you an authorized user of his credit card, for example, his history with that account can be imported to your credit bureau file, giving you an instant credit record. If he has handled the account well, that reflects well on you. But if he hasn't, his mistakes would also become yours. Any late payments or other problems could make it harder for you to get future credit than if you'd established your history without help. Even if you trust the person adding you to the card, you may not be able to piggyback on his or her credit. Some credit issuers won't report authorized users to the credit bureaus, particularly if the user is not married to the original card holder. If the point is to give you a credit history, the person who's adding you as an authorized user should call the issuer and ask how (or if) your status as a user will be reported. Apply for credit while you're a college student Credit experts used to warn college students away from those booths set up on campus by credit card lenders -- the ones that promise free stuff for signing up. It turns out, however, that there's no easier time to get a card than while you're a college student, said Gerri Detweiler, author of "The Ultimate Credit Handbook." Lenders are willing to take risks with you that they won't once you graduate, probably because they know that your parents' willingness to bail you out will end once you get your sheepskin. You still have to exercise some caution, though. Look for a card with a low or nonexistent annual fee and low interest rates. For now, just get one: Opening a slew of credit accounts in a short period of time can make you look like a risky customer. Apply for a secured credit card If you can't get a regular credit card, apply for the secured version. These require you to deposit money with a lender; your credit limit is usually equal to the deposit. You'll want to screen your card issuer carefully. To be frank, there are a lot of bad guys in this particular niche of the credit world. Some charge outrageous application or annual fees and punitively high interest rates. Your credit union, if you have one, is a good place to start looking for a secured card. You can also check Bankrate.com's list of secured credit card issuers. Ideally, the card you pick would: Have no application fee and a low annual fee Convert to a regular, unsecured credit card after 12 to 18 months of on- time payments Be reported to all three credit bureaus. If the issuer doesn't report to the credit bureaus, the card won't help build your credit history. Get a finance company card Gas companies and department stores that issue charge cards typically use finance companies, rather than major banks, to handle the transactions. These cards don't do as much for your credit score as a bank card (Visa, MasterCard, Discover, etc.), but they're usually easier to get. Again, don't go overboard. One or two of these cards is enough. If you get many more, you may find that later in your life these accounts could prevent you from getting the highest possible credit score. That's not a reason to avoid them completely, because right now they'll do you some good. Just don't apply for half a dozen. Get an installment loan To get the best credit score, you need a mix of different credit types including revolving accounts (credit cards, lines of credit) and installment accounts (auto loans, personal loans, mortgages). Once you've had and used plastic responsibly for a year or so, consider applying for a small installment loan from your credit union or bank. Keeping the duration short -- no more than a year or two -- will help you build credit while limiting the amount of interest you pay. Use revolving accounts lightly but regularly For a credit score to be generated, you have to have had credit for at least six months, with at least one of your accounts updated in the past six months. Using your cards regularly should ensure that your report is updated regularly. It also will keep the lender interested in you as a customer. If you get a credit card and never use it, the issuer could cancel the account. Just remember the credit tips mentioned earlier: Don't charge more than 30% of the card's limit. Don't charge more than you can pay off in a month. As mentioned earlier, you don't have to pay interest on a credit card to get a good credit score, and it's a smart financial habit to pay off your credit cards in full each month. Make sure you pay the bill, and all your other bills, on time. 7 credit-card trends that can cost you Here's what you need to know about rising rates, new fees, credit-card deals and other trends and traps that will affect you tomorrow and for years to come. By Liz Pulliam Weston How far we've come. Thirty years ago, if you had a credit card -- and many people didn't -- you probably had only one, and it came with a fixed rate. You couldn't use your card at the grocery store, the doctor's office or millions of other places. Your only reward for using it was being able to put off paying for the stuff you bought for a little while. Today, the typical American adult has four or five cards and uses them in one out of every four transactions. Hundreds of different rewards programs compete for your attention, and you can use your card for everything from apples to plastic surgery. So where do we go from here? Credit-card industry experts checked their crystal balls and weighed in with the following short- and long-term trends. Average interest rates will climb Today four out of every five cards has a variable rate, and those rates have been on the rise. Over the next year, credit-card issuers will continue passing along the Federal Reserve rate hikes and then some. The Fed raised short-term rates by two percentage points between February 2005 and January 2006. The average variable rate on credit cards during the same period rose nearly 3 percentage points, according to credit research site CardWeb.com from 12.84% to 15.75%. Many economists expect the Fed to raise rates another half point or so in the next year, which should boost the average card rate by the same amount or more. Meanwhile, regulators succeeded in forcing most issuers to revamp their minimum-payment formulas so that borrowers make principal as well as interest payments. In the past, required payments could be so low that a borrower might need decades to pay off a debt if she only paid the minimum. The combination of higher rates and higher minimums is expected to put a financial squeeze on more consumers, leading to higher default rates by the end of the year, said Tanya Azarchs, a bank-rating analyst for Standard & Poor's. How to use this news: If your credit is good, you don't have to tolerate rising rates. Banks are still competing fiercely for the best customers. "If your credit score is 720 or above, you should be paying 10% or less," said Curtis Arnold of CardRatings.com. Negotiate with your issuers for lower rates or take your business elsewhere. Arnold notes MBNA is currently offering several cards with 7.9% "fixed" rates. (Nothing is truly fixed in the credit-card world, but these rates aren't designed to fluctuate.) If your credit is bad, check out the resources in MSN's Your Credit Rating Decision Center for ways to boost your numbers. If you're having trouble making the minimums, stop charging and work out a plan to pay down your debt. Low-rate offers will continue, but with more traps Higher interest rates make those low- and zero-rate offers potentially more expensive for banks -- but that doesn't mean they'll go away. Instead, expect more fees and ways to trigger higher interest rates. One example: Chase recently removed the cap on balance transfer fees for some of its low-rate offers, Arnold said; previously, the fees had been limited to $75. "It doesn't seem like a big deal when the balance transfer fee is 3%," Arnold said, "but if you transfer $10,000, suddenly it's gone from $75 to $300." Depending on how long you planned to carry the balance, the extra fee could offset or erase any savings from the lower-rate offer. "You really have to do the math," Arnold said. "You could end up losing money on a deal like that." Issuers are also modifying the "low rate for the life of the balance" offers, which promise 0% to 4.99% rates on transferred balances until you pay off the debt. Some issuers now require borrowers to make a minimum number of purchases, which of course accrue interest at a much higher rate. Since your payments go toward the low-rate balance first, you could wind up accruing some pretty hefty finance charges on your purchases. How to use this news: It's always been important to read the fine print of any credit-card offer, but especially so now. You should know how long the introductory rate lasts, when and how much the rate will adjust, what fees you'll pay to transfer balances, whether additional purchases are required and if so, how many. Since you can lose your great low rate with a single late payment, set up automatic or recurring payments to ensure at least the minimum always gets paid on time. Then again, you can simplify your life considerably just by refusing to carry a balance. Interest rates won't matter -- although you'll still have to pay on time to avoid late fees. Great deals are coming -- and going Arnold pictures credit-card executives sweating away in their corporate towers, straining to come up with spectacular deals that will garner attention in a crowded market -- only to be appalled when savvy consumers figure out how to exploit the deal in ways the suits never intended. A classic example: MBNA's AAA gas-rebate card, which was among the first to offer 5% back on gas purchases. MBNA had intended this to be a general purpose card, but since there was no cash rebate on other purchases, many users responded by only using it for gas and using other cash-back cards for the rest of their spending. The card's gas-rebate deal has since been trimmed. Another instance: Discover initially required two purchases a month on one of its 0% transfer offers, but failed to specify the amount. Some users charged only tiny amounts, leading Discover to institute dollar minimums. "Some (users) buy two cups of coffee a month (while they get) 0% on balances of $15,000 to $20,000," Arnold said. "At the end of the year you've paid for some finance charges, but typically only a few bucks." Currently, 5% rebates on "everyday purchases" at gas stations, groceries and drugstores are all the rage, and Arnold expects the deals to get even better as companies fight for market share. But again, the best deals will get exploited and trimmed back, so take advantage while you can. How to use this news: If you carry a balance, concentrate on finding the lowest-rate card possible. But if you pay your bill in full every month, make sure to shop around to find the best rewards offers once or twice a year. Sites like CardRatings.com, Bankrate.com and CreditCards.com can alert you to good deals. Beware, though, of applying for too many cards, which can hurt your credit scores. Limit your applications to one or two a year, at most, and refrain from applying for new credit if you're in the market for major borrowing like a mortgage or auto loan. Fees will grow Average fees for late payments, over-limit purchases and other infractions have nearly doubled in the last decade as issuers relied increasingly on fee income for their profits, and that trend isn't about to abate. Arnold expects some issuers to boost their typical fee, currently around $39, over the $40 mark this year. At least one issuer has tried to channel consumer fury over ever-higher fees, but the result should make you pause. Citibank's Citi Simplicity Card promises no late fees if you use the card at least once a month, but Arnold points out late payments can trigger a super-high penalty rate of over 30%. "That doesn't sound consumer-friendly to me," Arnold said. How to use this news: You can save your credit score as well as your pocket book by avoiding late and over-limit fees. Avoid using more than half your credit limit at any given time, and set up automatic or recurring payments to make sure your bill is paid by the deadline. Consolidation won't spoil the party -- yet For most of the 1990s, 10 card issuers controlled about 80% of the credit-card business. Today, that's down to five, yet "banks are still hungry," S&P's Azarchs said. "They're still competitive." That's largely because there hasn't been much growth in the lending side of the credit-card business, Azarchs said. People already have a lot of credit cards in their wallets and aren't adding many more, so issuers try to grow by stealing business from each other. Hence all the low-rate offers and rebate deals. That could change if the industry consolidates much more, and many analysts expect more mergers in coming years. "Competition is always the thing that's driven this industry," Arnold said. The idea of less competition "scares me." How to use this news: If you're concerned about industry consolidation, let your lawmakers know. Otherwise, be prepared for less-generous offers and even higher fees if credit-card issuers continue their merger binge. It won't happen overnight and may not happen at all. But if you need it, this could be another excuse for paying off your credit-card debt while you still have plenty of low-rate options. Micropayments will grow Since issuers aren't making as much profit lending money, Azarchs said, they're looking to cash in by increasing the number of transactions they handle. That means encouraging more small-change transactions of $5 or less. Research firm TowerGroup predicts the volume of small electronic payments -- "micropayments" -- will grow to $11.5 billion by 2009 in the U.S. and $40 billion globally. "There has been a slow, steady march of credit cards replacing cash, and this is the last frontier," Azarchs said. "It's not like what happened when supermarkets began accepting credit cards, which was huge … but the credit-card companies are definitely looking for ways they can make money from processing transactions." You can already see the signs. Chains including McDonald's and 7-Eleven already accept plastic for small transactions, and Motorola recently announced plans to incorporate a payment chip in some of its cell phones. (Consumers in Asia already use their phones to pay at vending machines and other locations.) TowerGroup managing director Theodore Iacobuzio said such "contactless" options, where a cell phone or key fob is waved in front of a reader, will help fuel micropayment growth. Eventually, he predicts, contactless payments may supplant plastic, just as plastic supplanted checks and cash. But where credit card companies see profits, merchants see extra costs. Retailers must pay for card-based transactions, typically 1% to 2% of the total charge, which can wipe out their profit on the smallest transactions. Iacobuzio predicts retailers will find ways to reduce the costs, possibly through aggregating many small transactions as Apple does with its iTunes online store. How to use this news: Expect to see more retailers accepting plastic for small transactions. If you're carrying a balance, you should resist adding to it, even incrementally; otherwise, you can take advantage of the convenience and the possible advantage of being able to track more of your spending. Security will continue to be an issue Several well-publicized security breaches at merchants and credit-card processors have exposed millions of credit-card account numbers to thieves in the past couple of years. The major credit-card networks are cracking down, but they have their work cut out for them. Visa USA recently reported that the vast majority of the merchants it surveyed weren't properly protecting consumer data. Visa found only 17% of the 231 large merchants it questioned were following payment card industry guidelines regarding customer data security. "Securing payments is not something Visa can do alone," said Visa spokeswoman Rosetta Jones. "We need the participation and cooperation of everyone involved in processing the data." One of the biggest problems: retailers and processors are hanging on to data they shouldn't. Deliberately or because of quirks in the software they use to process card transactions, customer-account numbers and PINs may be stowed in unencrypted databases that are vulnerable to hacker attacks. The major credit-card networks, including Visa and MasterCard, will respond by fining credit-card issuing banks, which in turn will fine the merchants involved, said Avivah Litan, payment card industry analyst with research firm Gartner. That will help force better compliance, she said. "The networks are getting a lot tougher than they used to be," Litan said. How to use this news: If you're given a choice, don't let a merchant (online or otherwise) store your credit-card account information. Check your monthly statements for unauthorized activity or, better yet, use personal finance software or online account access to scan your accounts at least weekly. If you spot a problem, call the issuer immediately but then follow up in writing to preserve your consumer rights under federal law. Also, consider having at least two open, active credit-card accounts; replacing a lost, stolen or compromised card can take five to 10 business days, and you may want to have an alternate card available while you wait. Credit Card Project Directions: Track your exposure to credit card adds over the course of a week. You will need to report on where, when, type of card and the hook. You should have at least 12. Next you are to actively search for 8 credit cards. You will have to report on: Interest rates (Intro and regular), Balance transfers, Rewards, Annual Fees and Credit needed. http://www.creditcards.com/ Rubric: 75 pts – did you cover 20 cards completely? 25 pts – Typed 2 page report.
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