The New Face of FICO

This is a guest post from Greg Vandagriff. Be sure to check out his great new site, Equidash!

Last week I discussed the circumstances which led to FICO 08. Essentially the bastard child of Fair Isaac Credit Organization and mortgage lenders, the new credit scoring model will allegedly be a better predictor of defaults on mortgage loans. One could argue that the entire affair is nothing more than a desperate publicity stint aimed to placate lenders while still keeping them chained like dogs to the titan of credit scoring. Regardless of the intentions behind the revision, it is nevertheless beneficial to examine what it means for your score.

First of all, the newest model, once adopted, will polarize your score more efficiently. What this means is that the penalties to your score for minor infractions, such as a 30-day late, will be substantially lessened; whereas the penalties for more severe delinquencies, such as a large balance going to a collections account will be substantially greater. Overall, FICO claims, this change will result in most people’s credit scores increasing by a small amount. Three cheers for higher credit scores!

The second, and most publicized and potentially the most dramatic change to the model is the elimination of authorized user accounts from the credit scoring equation. Previously, if one were signed onto an account as an authorized user, one could quickly “inherit” the good credit of the primary account holder. This practice, often referred to as “piggybacking” was commonly used by parents to help their children build good credit at an early age by signing them on as authorized users. On the other hand, however, the credit repair industry is filled with shady operations that allow those with poor credit to improve their score by paying a certain amount of money in order to “piggyback” as an authorized user on the account of someone with impeccable credit. It is said that this practice dramatically inflated otherwise unremarkable scores.

The elimination of piggybacking means that if a substantial portion of your credit history is derived from authorized user accounts, you can expect to see a drop in your scores once the newest revision is implemented by lenders across the country. Consequently, you would be well advised to apply for additional lines of credit while you still can so that you at least have the means to build a powerful profile of independent credit.

Publicity stint or legitimate revision? It’s your call. Either way, the effects of FICO 08 are likely to be felt by a significant portion of the credit market when it is fully integrated by all three bureaus.

Popularity: 13% [?]

How to Handle a Sudden Windfall

You dream about it and all of a sudden it actually happens: a cousin you’ve never heard of dies halfway around the world and leaves you his fortune. Or maybe you suddenly hit it big at the lottery or poker table. However it happens, you are suddenly laden with an excess of moolah and life is sweet…or is it? Studies have shown that more than one third of lottery winners declare bankruptcy within a decade – and that scary number, my friend, does not include the number of lottery winners who end up just scraping by after hitting the big time.

Sure, you think you’d be a darling at being filthy rich, but do you really know what it takes to keep lots of cash while maintaining your sanity? Here are some ways you can hang onto both if you get lucky (financially speaking):

•    Know the risks. You assume it would never happen to you, but it does happen – someone strikes it rich and winds up without a penny. People who strike it rich and end up years later bankrupt don’t get there by accident and you could learn a lot from these folks. In many cases, poor planning, bad advisers, and overspending are the culprits. Steer clear of them and continue socking money away into a savings account. Yes, even when you are filthy rich you still need to pay yourself first.

•    Start to get smart about money. Before you hand over all your cash for someone else to take care of, you need to learn about investments, money management, and money in general. Read up using reliable resources.

•    Go easy on yourself. You’ll make mistakes and it’s ok to feel smug – or angry or frightened. You’ll need to give yourself some time to adjust. This is probably not the time to make life-altering decisions. Set aside some money to treat yourself and don’t pressure yourself to make major decisions right away.

•    Figure out your position and plan ahead. How much money do you now have? What are your debts and living expenses? What are your long-term plans? Can you get there on the money you have? What are your current banking limits? If you have really hit the big time, you may need to upgrade your banking options so that you enjoy accounts with added security.

•    Hire a team of trusted advisors. You can’t actually be wealthy alone. You will need some trusted professionals to help you avoid huge tax penalties, poor planning, and bad investments. The key word here is “trusted.” You need to pick your pros carefully – check references and recommendations – and once you do have advisors you will need to continue to manage your money and make decisions yourself. At minimum, you may need a financial advisor, an attorney, an accountant, and someone to help you figure out taxes.

A counselor or trusted therapist isn’t a bad idea, either. You will need some support when people start hounding you for money. A good team will keep you on track and will ensure that you stick to your financial plan so that your windfall lasts a long, long time.

Popularity: 12% [?]

When the Collectors Come Calling

In some cultures, worshipers are pierced with hooks and suspended from the hooks in mid-air to show their devotion to a specific deity. In our own culture, there is a ritual that causes as much psychological, if not physical, pain: a call from a collection agency. Most of us would gladly get a root canal – or several of them, in a row, with no anesthesia – rather than deal with a collection agency. These companies come calling when you don’t pay your bills on time, and they can be highly unpleasant. Ask around and you will hear some horror stories – humiliation, harassment, and tears.
Collection agencies are actually companies that work on behalf of creditors. If you haven’t paid your credit card bill, for example, your credit card company will eventually submit your name to a collection agency (or a collections department, if you are dealing with a larger credit company).

When someone from a collections agency calls, here’s how you can make it a bit less painful:

1) Pick up. Ignoring the calls will mean more calls – until the collections agency or credit just launches legal action against you.

2) Have a paper and pen handy when you pick up the phone. Note the time and date of each call and ask the collections agent to tell you their name and agency name. Do not talk further until you have this information. Since you will be revealing financial information over the phone, you should have some idea who you are speaking with to prevent identity theft. If the person refuses to divulge their name, hang up and call your creditor directly. Explain the problem and ask whether there is someone else you can speak with to resolve the problem.

3) Know what to do when things get ugly. The collections agency won’t advertise this, but a Joe Schmo like you does have some rights. You have a right not to be harassed by a collections agency. This means collection agencies cannot call you too frequently, especially if you are at work. They also cannot call you on Sundays, statutory holidays or before 7 am or after 9 p.m. Collection agencies cannot in general contact people you know, except to ask them for your number and address.

If a collection agency ever uses abusive language or seems to be doing something illegal, your best defense are the records you’ve been keeping of the phone calls. In your notes, write down exactly what was said by an agent and when. Call the collection agency to report the problem and then call your creditor to note that the collection agent is being a problem and you are not willing to work with someone using harassment.

Work with your creditors directly or have your creditors refer you to another collections agent. You can also make a formal complaint against the collection agency if they are doing something illegal. Just because you owe money that does not mean that you deserve to be treated badly. Make sure the collection agency knows it and make sure your creditors know it.

4) Play nice. If the collections agent turns out to be decent, you should make every effort to cooperate. It will make your life – and the agent’s – much easier. Explain to the collection agent what the problem is and when you will be able to pay something. Be sure to add a few days to your estimate. If get paid on the first, tell the agent you can pay something on the fifth. That way, if you get the worst cold in the world or are running behind, you won’t be dinged again. And if you pay early, you’ll be golden.

Popularity: 12% [?]

7 Zany Ways to Stop Overspending

Are you spending so much that your credit card is cowering in your wallet? If you are giving your debit cards such a workout that your accounts are often empty, you need to stop overspending. This can be as tough a challenge as stopping smoking, which is why some wacky tips are in order:

Freeze your credit cards. Yep, you’ve heard of this one, but it does work. The idea is that you place your credit card in a bowl of water and toss it up in the freezer. The card is in your freezer, not your wallet, where you can whip it out any time you see a sale. Plus, to use the card you need to thaw it out slowly – which gives you time to think about an impulse purchase. Note: this tip will not work if you know your credit card number off by heart and can just call up a store or order online with your memorized number.

Eat at home before you head to the grocery store. If you go shopping on a hungry stomach, you will spend more because everything will look good and prepared meals (which are worst for your waistline and wallet) will look best.

Quit browsing. Window-shopping, trying things on, flipping through catalogues, and even looking at ads in your favorite magazines all stir up desires for specific items you don’t need. Make lists of what you need and do quick run-throughs to buy only what you need when you need it. Call up stores and get yourself off mailing lists so that you stop getting those too-tempting catalogues.

Turn off the TV. The ads on TV are designed to make you want, want, want. The clothes and items you see on your favorite shows also tends to make you want specific items. Read a book, go out and play a game of tennis, or listen to some music. All are better options than watching ads on TV.

Procrastinate on purchases. When you do need something – new shoes, for example – tell yourself to wait another month or two. It will reinforce the fact that you don’t really need a new item and you will save some cash, too. Plus, you may find that taking your shoes in for new heels makes them as good as new so that you don’t need a new pair after all.

Set up an exercise schedule. If you get a “high” from shopping, try to find a runner’s high by working out instead. As an added bonus, working out will make you healthier and will keep you busier so that you can’t spend as much. Don’t sign up for a new gym and buy yourself new work-out clothes, though. That’s not exactly the point. Instead, meet up with someone for walks or dust off that old exercise bike.

Make a game of earning more. Rather than getting your kicks from spending, try to get them from earning. This month, make it a game to see how much extra money you can earn. If you make $2000 a month usually, volunteer for extra work, ask for a raise, hold a yard sale to sell off junk you don’t need and generally go out of your way to earn. You might find a new addiction – and earning is far more fun than spending.

Do you have any techniques for holding off those ‘must-have’ purchases? 

Popularity: 14% [?]

Why Do We Get Into Debt?

A friend of mine was dating a Turkish gentleman who had never lived in the United States.  While they were shopping she found a pair of boots she liked and decided to buy them – with her credit card, of course – and he was absolutely appalled.

“Why don’t you use cash?” he asked her.

“I don’t have enough cash to pay for them,” she explained.

He was flabbergasted. “Why don’t you save up a little each week and then buy them when you have the full amount?”

“But it’s only a hundred dollars,” she protested.

She went back later and bought the boots using her credit card when he wasn’t with her.

To my friend, whipping out a credit card was a socially acceptable way to get her hands on something she didn’t have the cash for. To her boyfriend, it was an absurd use of credit and really boggled his mind. In his culture, needing to use a credit card for everyday purchases was embarrassing. If you wanted a pair of boots, you simply saved up the money to buy them.

We get into debt because it’s socially acceptable. It’s the norm. Ask a stranger on the street to open his or her wallet and there’s a good chance that there are a few credit cards within its folds.  People who do all financial transactions using cash are considered exceptional to the rest of society.

What would happen if every time you presented a credit card to make a purchase the clerk was shocked and appalled? You would probably be much less likely to impulsively buy a pair of boots on your credit card if it was a public demonstration of your financial ineptitude.  In our society, though, buying boots on a credit card is simply business as usual.

Auto loans, mortgages, student loans, and credit cards are all par for the course for today’s consumers. It’s comforting to know that even though we’re wallowing in debt that we aren’t the only ones. It would be a lot harder to be as comfortable as we are in debt – and we would probably pay it off a lot sooner – if there weren’t so many other people in the same situation.

There are plenty of other reasons why people get into debt. Sometimes life circumstances just make it happen: the house burns down, the car gets wrecked, you lose your job. The truth of the matter though is that if debt wasn’t so accepted and expected then the same people who find themselves in financial distress may have instead had a large emergency account sitting somewhere collecting interest, so they wouldn’t have to turn to credit to pay for emergencies.

After all, if you didn’t have money going to credit card repayments AND student loan repayments AND mortgage repayments AND car repayments (you get the point…), imagine how quickly your savings account could grow.

The only way to get out of debt and stay out of debt is to change your frame of mind.  Yes, debt may be acceptable and everyone else around you is in debt, but until you decide that it isn’t okay for you, you’ll always be under the impression that debt is just something you have to accept and there is no way out.

Of course there’s a way out: Be a non-conformist. Pay off your debt and don’t incur any more.

Popularity: 17% [?]

Want to Drop Out of the Rat Race for a Year?

When you’re sitting at your cubicle or desk, you may dream of time off. You may think you have to wait until you’re retired to enjoy quality time away from work, but that’s not always the case. A growing number of people are taking leaves of absence from work – and a growing number of companies are allowing “personal-enrichment breaks” with no penalties. Many employers are even willing to hold onto your job for you. If you are seriously thinking about papering your walls with printouts of “all work and no play make me a dull boy” maybe it’s time to consider some leave time.

Why do it?

There are lots of reasons to take a break from work. If you hate your job and your life – really hate it – a break can give you, well, a break from that, as well as a fresh perspective that will hopefully help you turn things around. A few months or a year off from work can even help you pursue something you have always wanted to do – travel, find yourself in Tibet, have a family, pursue a hobby, or pursue that elusive degree. Life is short and we often put off big dreams until we “have the time.” A leave from work lets you recharge and lets you pursue your dreams. You can try to write that best-seller or break into Hollywood, so you don’t have to spend you life wondering whether you could have been a contender.

What’s the cost?

A year free from your place of work isn’t free. Unless your employer is offering you paid sabbatical time, you will be bringing in far less per year and that will mean less money to spend and less retirement money down the line. If you have to resign, you may not find your job waiting for you when you get back and you may be setting your career back a few years. You need to plan carefully so that your break doesn’t end up being a big regret. Losing a lot of money so that you can sit around in your sweats watching soaps isn’t usually the point of a year off from work.

How to make it happen? 

Planning a year off starts with some heavy-duty planning. What exactly do you plan to do while you’re away from the daily grind? You’re trying to get away from work so you don’t want t a minute by minute itinerary but it’s important to know how much your plans will cost. What do you want to achieve and do? What will that take personally and financially? How much time and money do you need to pursue that degree or that travel dream? Look at how much you spent during the past six months, and add your break plan costs to that as well as any insurance costs your boss will no longer be covering. That is your cost for not working. How long can you afford to take off? If you plan on resigning, you need to subtract three months, which is what it may take you to find a job after you come back.

How to find the cash

Once you know how much your “free” year will cost, you need to find the money. There are scholarships that may help if you are heading off to school and grants that may be a big plus if you are headed off to pursue some artistic attempt. Beyond that, you could try paying down your debts as much as possible to get some wiggle room. Or grab some cool seasonal work that will pay your way. Spend a lot of time looking and only tap into your retirement savings as a last possible resort.

Popularity: 14% [?]

Justifying 3-6 Months of Expenses in Savings

First, thanks to Megan for asking the question. The Dave Ramsey debate is still raging on so if you haven’t weighed in, please do so! We’d love to read your opinions. But Megan asked how we can justify leaving 3-6 months worth of expenses in a savings account only paying 3% when there are clearly other investments that can offer a better return.

The answer: that money is intended to cover expenses in the event you lose your job, become disabled and unable to make payments for a period of time, or if something happens to one of the breadwinners in your family. Yes, there are certain insurances that cover most of these things; however, most have stipulations on how long before they kick in, how much and how long they will make payments, and even as to what will be paid. There is no such insurance for being laid off. Can your family really afford to take the risk of not being protected in the event one of these scenarios takes place? Can your credit report afford it?

Some people have suggested the use of credit to cover these types of emergencies; however, I think that’s asking for trouble when you start relying on your credit cards to cover your monthly expenses without the intention of paying them off at the end of the month. An occasional emergency here and there isn’t a big deal and a good reason to have a credit card in the first place. But we’re talking about having at least six months of expenses saved here. If you lost your job and were out of work, how would you pay the credit card back? You could end up defaulting on the card and disparage your credit report in the process. This is also why I think it is important to have the savings account and contribute as much as you can until you reach the six month’s of expenses, even if you have debt. Again, if your income is suddenly gone, how would you pay for anything? Credit is an option for a while, but eventually that runs out and the bills have to be paid. What then?

So for me the justification is simple: I need this money just in case something was to happen to me or in case I lose my job. I would rather only be paid 3% and pay no penalty fees if an emergency comes along as opposed to earning a better rate of return in investments but then have to pay penalties and taxes if I need the money. Not to mention the fact that investments can lose value and even though I started with six months, I could potentially have nothing if I ever need it. Investments are meant for the long haul, pulling out early could hamper your earnings. However, there is no need to have more than six months expenses saved at any one time. I’d say more than that and you’re losing out on better opportunities.

Still, that liquid savings account is fairly hard for some folks to swallow and I completely understand. Another option to consider would be certificates of deposit (CDs). Now, CDs aren’t 100% liquid; however, they are 100% safe and your money will be there when you need it. Most institutions will charge you a fee to withdrawal early, but most don’t touch your principal, only your interest. So, if you ever need that money, it’s there and it’s safe; but it’s also earning a little better than just a savings account. That option is completely up to you. I personally like the savings account because I just don’t like to spend money when I don’t have to. But that’s just me.

What do you think? Is it justified, or just a waste of time?

Popularity: 20% [?]

Carnivals and Weekly Roundup

Be sure to check out these great posts from the Personal Finance Blogosphere:

• The Digerati Life has a great post on setting up a Will/Estate Plan - definitely worth checking out if you don’t have one already.
• Free From Broke makes an interesting point about being focused. Having focus in your life is very important, but only if it’s on the right things!
• Boston Gal has an intriguing piece on the cost of ‘going green’. We all want to make a difference when it comes to helping the environment, but how much are we willing to spend on an individual basis to reduce our carbon footprints?
• The Happy Rock has a post on slashing your budget to get you that extra step closer to being debt free.
• James from DINK Finance speculates about the McCain’s net worth. He estimates it could be higher than a billion dollars. Yikes!

We were also listed in a couple of articles this week - Money Hacks over at Moolanomy and the Carnival of Financial Planning at The Skilled Investor.  Check em out!

Popularity: 13% [?]

FICO’s Fall From Grace

This is a guest post from Greg Vandagriff. Be sure to check out his great new site, Equidash!

In the wake of the financial cataclysm commonly referred to as the American mortgage meltdown, lenders found themselves in a precarious position as their highly-leveraged empires began to collapse under the weight of mortgage fraud, greed, and dishonesty. Confronted with a problem entirely of their own making, these bankers did what any self-respecting person would do in the same circumstances: they looked for someone else to blame.

Who to blame, though? The credit industry was caught “red-handed”, and they couldn’t get away with blaming the disaster on just anyone; they needed someone on the inside to take the hit. They needed a fall guy, a sacrificial lamb. Faced with this decision, it didn’t take long for creditors to start pointing fingers at Fair Isaac Credit Organization (FICO). The monopolistic hegemon of the credit scoring industry was the perfect scapegoat.

FICO boasts the lion’s share of the credit scoring market and consequently enjoyed the reputation of owning the most widely-used credit scoring models in the world. By smugly using this advantage to force-feed their formula down the collective throats of the credit industry, FICO was untouchable. They were above the credit bureaus, the lenders, and the borrowers. Or so they thought.

You see, the credit industry has something of a love/hate relationship with FICO, and recent events, combined with FICO’s penchant for behaving like a spoiled brat, have dramatically emphasized the “hate” portion of this association. After all, why should lenders have to pay FICO to produce a score that doesn’t accurately portray a borrower’s creditworthiness?

Suddenly the tables had turned on our dear friends at FICO. Now their reputation for having the most widely used credit scoring models was turning against them as those algorithms “failed” to predict widespread defaults across the country. Having paid millions of dollars in exchange for the use of a reputedly infallible scoring model, lenders were determined to get their money’s worth from FICO, even if it meant beating the tar out of the company’s image and reputation through widely-publicized criticism in the media.

Granted, FICO never claimed their formula was the sole, infallible predictor of default on mortgage loans… and yes, there technically were massive loopholes in mortgage underwriting guidelines that were mutually exploited by both loan officers and borrowers… but this wasn’t about justice, this wasn’t about “right” or “wrong”. This was about saving face, dodging federal indictments, and buying precious time to salvage the mangled, disgraced husk of one of the oldest industries in the country. Cold as it may sound, this was business.

And you know what? It’s working. FICO is feeling the pain. Want evidence of this? I give you FICO 08. The latest revision to their scoring models comes across more as a desperate knee-jerk reaction to the criticism leveled at them by the media than anything else.

Now before you take pity on poor FICO, understand that they had it coming. They forfeited all rights to pity when they:  1.) Embraced the practice of taking advantage of consumer ignorance by marketing an insultingly simple product  via quasi-celebrity branding and 2.) Embraced the practice of screaming like a little schoolgirl whenever someone challenged their market dominance.

Next week we’ll take a closer look at FICO 08 and whether or not you should care about it.

Popularity: 13% [?]

Creating a Financial Emergency Plan

Have you ever seen those fire extinguishers behind glass at hotels and other public buildings? The idea is that if there is an emergency, you break the glass and can put out the fire with the extinguisher. You need an extinguisher in your financial life, too. You need something that you can’t access too easily – like when there’s a sale at the mall – but you can access easily enough when a real emergency crops up. Here’s how to build your plan:

1) Figure out where you can make money. Plenty of folks worry about losing their job or suddenly coming up short. Some worry so much that they get ulcers. You’re smarter than that because, hopefully, you know that money is a little like cookies – You can generally make more if you are able-bodied and healthy. Therefore, figure out how you can start making money fast.

Temp agencies are a good place to start and generally allow you to make a few bucks fast whenever you run short. Find a few in your area and find out how long it would take you to apply. Temp agencies have long been the secret weapon of starving artists and they are remarkably handy in a pinch. Also, look up information about jobs you can take on right away – freelance work or work for a friend – which can net you cash quick. That way, if you suddenly find your cash flow interrupted, you won’t skip a beat.

2) Figure out where to make money if you are not able bodied. It’s not just job loss you need to worry about. Car accidents and illness can deprive you of a paycheck and can make it very hard to work. Rather than fretting about the worst, look for passive ways to make income. Passive income means that money keeps rolling in, even if you are on the couch. Everyone needs a passive form of income in their lives. Renting a vacation home, or having a room in your house you can rent can provide you with much-needed income in the event of a problem.

3) Start saving – a lot. You need to have at least 3 months of income in a savings account for real emergencies. If you’re smart, you’ll have a lot more than 3 months. No excuses. Skip Starbucks today and start saving. Get in touch with the childhood joy of a piggy bank. Just save.

4) Pay down those debts. In a financial emergency, it’s your debts that will sink you, - you’ll have to keep paying them off even when you can’t afford to do so. Plus, any savings you have will be eaten away by debt repayments. Find ways to pay down your credit cards and other obligations and you will be safer and enjoy more money each month, too.

5) Get some Credit – just in case. If you know your job is in trouble or you may be facing a huge problem, consider getting a line of credit or a low-cost credit card now, if you do not have one already. This is especially important if you have good credit. Once the problem strikes, you may have a hard time maintaining credit scores or passing an employment verification, and it’s nice to have some cash you could use if you got really hungry.

6) Work it out on paper. Stuff happens – loss of work, sudden illness, a sudden huge bills from the IRS. Get in touch with your inner worry wart and write down the worst-case scenarios. Then, write down what you could do in each case. Pack up the paper and file it away with your financial statements. When disaster strikes, you won’t have to panic. You can start implementing your plan right away.

Having a financial emergency plan isn’t about being a pessimist, it’s about being a realist. With a bit of luck, you’ll never need to ‘break the glass’, but it doesn’t hurt to have a contingency plan in place. Remember: Hope for the best, but plan for the worst.

Popularity: 16% [?]