Last evening I was talking with a friend, her plans to buy a new car. While we were discussing models, features, prices, I asked her what her credit score looked like? She stopped and thought about it and realized she didn’t know! I didn’t need to say anything else.  She knew right away that she’d be going into the car dealership at a big disadvantage if she didn’t know what her credit score looked like.

That conversation got me thinking about the importance of maintaining good credit scores and being informed about what is on your credit report.  Here’s a short FAQ about credit scores.

What is a credit score? – A credit score represents a person’s creditworthiness. It is a score calculated by taking into account a person’s credit history, promptness of payment, repayment of debts and loan defaults.

Why is it important? – A credit score becomes immensely important when trying to secure a loan; home mortgage, car loan, credit card or an insurance policy. Credit score not only determines your eligibility for credit, but also the interest rate that you have to pay. The higher your credit rating the less interest you’ll pay.

Who calculates my credit score? – There are three major credit bureaus in the US, Experian, TransUnion and Equifax.  All three secure consumer credit reporting information from the nation’s banks and financial institutions and apply a score based on the FICO score developed by Fair Isaac Corporation and their own VantageScore. FICO scores range between 300 and 850, while VantageScore ranges from 501-990. As an example, a FICO score of 720 and above is usually considered excellent and will qualify for the best interest rates available.

Can I know my credit score? – Yes you can, but at a price. You are entitled to a free credit report from each of the three rating agencies once in a year. Beyond that, you’ll have to pay in the neighborhood of $15 or more for your scores. Many large loan providers calculate the average of the three credit scores before sanctioning a loan. So it is advised that you get your credit scores from all the three agencies before applying for a large loan.

How do I improve my credit score? – While there are many ways to increase your credit score, it all boils down to these four basic rules of thumb.

1. Make your payments on time, even if it means paying only the minimum due amount.
2. Keep your credit account balances below 50% of your total credit limit for each account.
3. Avoid too many credit inquiries in a short period of time.
4. Never default on a loan.

 

 After the subprime crisis, it is the credit card debt crisis that many financial analysts and economists are predicting to hit the country. Many average Americans seems to be using their credit cards for all the wrong reasons, falling prey to fancy deals and getting into debts.    

In case you are one among those trying to get out of a messy credit card debt trap, here are some tips that might help:

1.    Try balance transfer to consolidating debts to 1 or 2 cards If your debts are spread across different cards try consolidating those into one or two cards. Most credit card companies allow balance transfer and offer incentives for the same. Assuming your credit card issuers A and B charge 16% interest and a Card B offers you the balance transfer option at a rate of 8% and an introductory period of 4 months. It means you can transfer the debt of say $2,000 in Card A to Card B. The sum of $2,000 will attract an interest rate of 8% between say October-January. You can use this period to manage your debts better. If you still haven’t settled the debt, then February onwards the balance amount to be paid will attract an interest of 16%. Card companies allow balance transfer of up to 80% of the credit limit. So if you have a credit limit of $10,000 in your credit card A, then you can transfer up to $8,000 to your card B.

2.    Restrict the number of credit cards If you have credit cards with varying interest rates, then after settling all the debts, cancel those cards which have a higher interest rate. A maximum of two credit cards are sufficient to meet more than your basic needs. It is also advisable to avoid using your credit card until you have settled your debts spread across your cards.

3.    Try breaking your savings account to repay If you have some money in your savings accounts, you can try breaking that to settle the debts. Of course it hurts to break the savings, which you have planned to use for your wedding or your child’s education. But instead of having to live with mounting debts, harassing creditors, bad credit ratings and stress, it is better to forego the interest on your savings account and repay your credit card debt.

4.    Get a home equity loanIf the roof above the head is the entire asset you have, you can try considering a home equity loan to pay off your card dues. The debt on your house may attract an interest rate of 6-7%, which would be way lower than an 18% charged by your credit card issuer.  Two things to note here: ·         If you haven’t paid your mortgage fully then you cannot take a loan on your house. ·         Once you have paid off the credit card dues, finish off the loan on your home equity loan as soon as possible. Else you will end up with both home loan and credit card dues to be paid.

5.    Confront your creditor with your problem Okay, you neither have savings to speak about or a house to bail you out. The next best option would be to talk to your creditor and explain the situation. Tell him that you lack resources to repay the huge debt and the mounting interest. Ask for renegotiation of interest rates or extension of repayment period. Apprise them of your situation honestly and let the creditors believe that you are serious about repaying your debts. Chances are that your creditors will lend an ear to your pleas and help you settle your debts.

6.    File for bankruptcy This is the last resort, if you have exhausted all options to settle your debts. When a customer files for bankruptcy, the credit card companies are required to write off all or most of the debt. But before you jump to the option think of the consequences. First you should qualify for bankruptcy. The rules for declaring bankruptcy have become tougher over the years. The filing of bankruptcy will remain in your credit record for 10 years impeding almost all chances of acquiring credit, loans and mortgages of all kinds in that period. In addition you have to cough up a hundreds of lot of dollars to filing for bankruptcy, your attorney fees and so on.

The impact of the economic crisis facing the country has started trickling down to lay persons like us. I was speaking to my sister Samantha over the phone just a while ago which actually prompted me to post this blog. Samantha works in an IT company which has just announced its plans to lay off employees. Thankfully she does not feature in the firing line. But she was worried that any time soon, it could be her turn to be shown the door.

There are many reasons why companies lay off employees. When the economy was bullish orders were flowing in big and fast and companies needed people to execute the work. Now that there is a slowdown, orders start dwindling in size and number and in effect the requirement for the human resource also goes down. To add to the misery of the companies banks have started restricting loan disbursal to businesses or charge higher interest rates due to the liquidity crunch, throwing a spanner in the development plans of companies. These are just two of the many reasons why jobs are laid off.
It is important to be prepared for the worst in such times and let me suggest how:

1. Start creating an emergency fund
Traditional wisdom suggests that one has to save around 3 months of one’s salary as an emergency fund. If you have not done it so far, it is not too late to start doing it. Check all the possible ways in which you can save money. It is ok if you do not spend your weekends at the mall or hangout for a beer with friends for a few weeks, at least until you have saved up a decent sum for your emergency needs.
 

2. Get mentally prepared
As much as the financial preparation, it is important that you mentally prepare yourself for the worst. The emotions of people getting laid off range from anger, guilt, low self-esteem to a feeling of helplessness. Understand that when you are in a boat and the stream is rough you just have to sail along. No point finding faults with your boat or cursing your fate. Remember there are things beyond your control. Just keep telling yourself that it is just an opportunity for your to realise how tough you are as a person.

3. Start networking
Even as you are still in your job, rummage through your phone book, revive old contacts, make calls to people who matter, just to say hello. Let people remember that you are still around. You can subtly hint them that you are looking for a change in job. You can also start circulating your resume among friends and job sites.

4. Prioritize your debts and investments
Make a list of the debts and loans to be paid off and prioritize them. By paying your secured loans like mortgage and car loans regularly you can ensure that they are not seized for non-payment. Try not to default on your insurance premium payment either; else the whole purpose of having a policy will be lost. And avoid breaking your 401(k) or retirement plan as much as possible. Withdrawals from your retirement plans are subject to taxes and a 10% penalty as well.

I’ll never forget my first paycheck. When I was a kid, my parents gave me an allowance for doing chores around the house, although I think I spend more time trying to figure out how to get out of doing them. I earned additional cash here and there mowing lawns, babysitting, and I even had a paper route for all of a few weeks. But, I’d always been paid in cash or the occasional personal check. My first real paycheck was something different. All of a sudden, I was a wage earner and a tax payer and it made me proud. Made me feel grown up.

Of course, that first paycheck and the ones I collected for the next few years were meager and were usually spent in an afternoon at the mall and an evening of pizza and beer with friends. The days leading up to my next paycheck were usually pretty sad. I lived a duel life. I was rich, then poor. Rich again, and then poor…you get the picture.

Much to my surprise, when I finished school I was employable and joined the White Collar workforce. Now my paychecks feature a couple more digits and a comma separating them! What a time to be alive! The extra cash lifted me out of the boom and bust cycle I’d been in since that first paycheck. All of a sudden I had more money than I knew what to with. So, I did what any good American does. I went out shopping!

First, I upgraded my car and then I moved into a new, bigger apartment with a friend. Next, I furnished that apartment; flat screen TV with surround sound, sofa, chairs, tables and random things too numerous to list. My place is great and I my ride is ‘Pimped’, but guess what? I’m now back to that boom and bust cycle I thought I’d left behind forever.

Turns out, after I pay the bills my much bigger paycheck looks a lot like that first one. It feels like I’m now paying a lifestyle tax and that tax eats up a lot of my earnings. But hey, I’m college educated, I should be able to figure this out, right? Well actually, I have figured some of it out. Since I didn’t acquire and pay for my new lifestyle as part of some organized plan, when the major spending was over, the aftermath was just a bit shocking. But now I do need a plan. A plan for how to budget my money so I know how much I have left to spend after my bills are paid. And I need a plan to execute and track my progress.