We've talked about budgeting our income to include setting something aside for emergencies.  We shuld also make sure that we do not overextend ourselves when it comes to paying our creditors.  Our credit score is basically the bureau’s idea of our ability to repay our debt obligations.  It is highly affected by several factors.

Credit history

     Our credit history is the biggest determinant.  If we have a poor track record of paying bills or paying them on time, a new creditor is less likely to want to take that chance with us.

Debt to credit ratio

     Our debt to credit ratio is also a big factor.  If we are close to our credit limits with most or all of our accounts, a new creditor will not want to get involved.  When we max out our credit cards, we are showing creditors that we are poor money managers.  We buy more than we can afford.  A new credit line will only make it easier for us to get into worse debt.

     Also, when we are close to our limits on our cards, our required payments may get high.  A new credit line will only be an additional bill, and a creditor may not want to take a chance that we cannot afford to pay the new bill.

Length of history

     The length of time that our credit has been established gives a creditor a track record.  If we don’t have a long history, a creditor may not be able to get a good idea of our ability and willingness to pay.

Number of open accounts

     Opening lots of credit lines can have a negative impact on our report and our credit score.  This is especially true if the accounts are recently opened.  Creditors will wonder why we are so desperately seeking so much capital.  Too much credit can lead to trouble.  They don’t want to compete for our payment.  They want to feel comfortable in knowing that they will receive their payments as expected.

Scores are important

     Each bureau uses a different scoring system, but the bottom line is the same.  Any score under 600 shows a creditor that we are a high-risk borrower.  A score in the 600s is average.  A score over 700 is preferred.

     Let’s look at the difference a score makes.  Although mortgage interest rates fluctuate over time, there is a difference in 30-year fixed mortgage interest rates between borrowers with different scores.  For example, if a borrower with a score in the low 500s wanted to purchase a home, the mortgage interest rate could be 9.29%.  A score in the high 700s could drop the rate to 6.23%.

     Since a credit score can affect our interest rate by as much as 3%, our mortgage payment can end up being hundreds of dollars a month higher.  Let’s look at this from another perspective.  Considering principal and 6.23% interest over 30 years, a house could cost about $552,000.  The same house at 9.29% interest would cost about $743,000.  That difference in interest changes the price on the house by almost $200,000.  Imagine what other things we could do with that money!

     We should be extremely careful as we make our purchasing decisions.  Irrational choices now can end up costing us more than it’s worth later.

     The concept of paying off debt quickly and inexpensively is not bad in itself. In fact, it may help us move more quickly toward working on strategies to enhance our retirement income.  Consolidating bills to get one payment and a lower interest rate can be a good thing.

     Many of us may feel that we are unable to get the excessive debt under control on our own.  We may decide to turn to a credit counseling agency or a debt consolidation company to help us tackle this stressful situation.

     However, not all credit counseling and debt consolidation companies have our best interests at heart.  It is important to carefully review the practices and strategies employed by these companies in their efforts to “help” reduce debt.

Credit reports can be damaged

     Often times, these companies will use methods that negatively impact our credit scores.  For example, the company may collect the monthly payment, but the creditors will not get paid right away.

     The credit counseling company will usually collect its fee first.  Some will take a small percentage of each monthly payment, while others may want their fee as a lump sum paid off before the actual debt reduction begins.  In fact, depending on the contractual agreement, it may take several monthly payments to pay off the debt consolidator.

     Then, the money paid to the consolidation company will sit and collect for several months until a lump sum settlement offer can be made to one of the creditors on the list.  During this time, all of the creditors are usually reporting late payments to the credit bureaus.  Once the settlement offer is accepted by the creditor, there will also be a report issued to the credit bureau that the payment was “settled” for less than the full balance that was due.

What is our own motive?

     Another thing to consider is our own reason for choosing this route.  As mentioned earlier, many of us want someone with more experience to help us make some headway in a time where it seems like we are only spinning our wheels.

     But there are others who choose to take advantage of the system.  They will use the program to free up the credit cards, and, in turn, run them back up.  I know because I’ve done it – twice.  This doesn’t make things better.

     If freeing up credit cards is the intent, then we should not consolidate.  If we are seriously looking for a fresh start, we can consider consolidating and having a credit card cutting ceremony.  This way, we don’t have to worry about running the cards up again.

     To make sure that everything is really safe, we might have to cancel one or two of the cards.  I used to have my credit card numbers memorized, so I was still able to order new things online and over the phone.  If we are not disciplined, we may have to go the extra mile to protect ourselves from ourselves.

     The idea of getting out of debt is great.  It brings a sense of freedom that is priceless.  It can be accomplished with a debt consolidation company, but it can also be done individually.  Regardless of the method we choose, as we work toward the end goal, let’s be focused and determined so that we don’t hinder our own progress.

     Many of us have noticed some changes with our credit cards lately.  In an effort to protect consumers, the credit card industry has been forced to make some changes. 

     We saw how credit card cash advances and advance tax refunds brought money problems to many households.  Fortunately, some of the changes coming with the CARD Act will help consumers avoid problems that can lead to serious and long term financial trouble.  On the other hand, creditors are finding new and creative ways to remain profitable.

Overdraft fees

     At one time or another, most of us have been unfortunate enough to have mismanaged our checking accounts and been charged an overdraft fee.  The Credit CARD Act is severely limiting banks’ abilities to charge these fees.  As of July 2010, consumers will have to opt in to be able to overdraft using their debit cards.

Balance transfers

     Teaser rates for balance transfers are few and far between.  While many credit card issuers used to offer extremely low rates for six months to one year on balance transfers, the new rules are making these offers rare.

     The Act has restricted creditors’ abilities to adjust rates on credit card balances.  As a result, introductory rates may be lower than the card’s standard rate, but they are much higher than the 0% that many of us had become used to seeing.

Credit cards for borrowers with bad credit

    It will be harder for people with low credit scores to apply and be approved for credit cards.  In the past, creditors were willing to offer credit cards to borrowers with bad credit.  The issuing credit card company would allow higher risk borrowers a card with a low initial credit limit.  The interest rate would be higher than a “regular” credit card, and there would be an annual fee charged whether or not there was any activity on the card.

     Since the Credit CARD Act has attempted to reduce fees paid by consumers, creditors are having a hard time making these higher risk cards available while still being profitable for them.

Prepaid cards

     Many higher risk consumers who are not able to get a credit card will find themselves opting for a prepaid card.  These cards require users to make a cash deposit to the card.  They are then able to use up to the prepaid balance that is available on the card.

     New rules will require card issuers to disclose all fees to their consumers.  On a positive note, the Act will also extend the length of time that cards are good so that inactivity does not cause a consumer to lose the balance on the card.

     However, card issuers may impose higher upfront and reload fees to make up for lost profits from expired cards.

    Since many of the new rules have not yet come into effect, we are still unsure of how consumers will be impacted.  But, in a time of such uncertainty, it has become much more important for us to regularly review our credit card and bank statements, as well as those “fine print” disclosures that come in the mail.

     We looked at the most important aspects that are considered when determining our credit score.  Today, we will look at some of the government’s efforts to reform some of the corrupt practices that the credit card industry has used against borrowers.

     It is important to understand the changes happening in the credit card industry.  Even borrowers with great credit have found themselves negatively impacted.

     For example, millions of consumers were hit with reduced credit limits on their credit cards.  These reductions came even if the consumers were not considered “risky.”  As a result of the reduced credit limits, consumers ended up with higher debt ratios and many consumers’ credit scores dropped.

     In May of 2009, President Obama signed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act. 

     Here is a summary of some of the main changes expected in the credit card industry.

Notice requirements

     Creditors are required to give 45 days’ notice regarding any significant changes to the terms of a credit card agreement.  Previously, only 15 days’ notice was necessary.

     If borrowers do not agree with upcoming changes, they have a right to cancel the account.  The creditor can increase the minimum monthly payment, but they cannot require the balance to be paid in full.

     Creditors are also required to provide statements at least 21 days before the payment due date.  This is one week longer than what was previously expected.

     Disclosures of credit card agreements must also be improved.  This includes posting the agreement on the creditor’s website.

Interest rates and fees

     Interest rates cannot be raised on existing balances for one year after the account is opened.  After that, the new, higher rate is limited to new transactions.  Teaser rates must be fixed for at least six months.

     Some borrowers have multiple interest rates being applied to different portions of their credit card account.  When borrowers pay more than the minimum payment, the additional funds must be applied to the highest interest rate’s balance.

     Creditors are no longer able to charge a fee for borrowers going over the credit limit.

Protecting younger consumers

     In an effort to better protect young and impressionable college students, borrowers under 21 cannot obtain credit cards on their own.  Younger borrowers will need to submit a written application with the signature of a co-signer over the age of 21.

     Ideally, this new provision will reduce the number of college students who graduate with huge credit cards bills racked up over the four year college experience.  It will enable these students to graduate in a better financial position so that more of their paychecks can go to saving and investing than to debt reduction.

     The changes outlined in the CARD Act will help protect consumers against unethical practices.  However, these changes alone are not enough.  Borrowers must become more informed credit card users to better guard against falling victim to their creditors.

     Since the meltdown of the financial industry, the ability to borrow money has become more and more difficult.  The days of obtaining large loans with no proof of income are gone.  In fact, retirees often find it challenging to refinance a mortgage based solely on their retirement income.

     Solid credit scores are much more important when trying to obtain a loan for any reason.  A better credit score will not only improve the chances of obtaining a loan, but also allow for better interest rates on the funds borrowed.

     Today, we will look briefly at some of the most important aspects that are considered when determining our credit score.

Payment history

     Being on time is a critical component in maintaining a good credit score.  Lenders want to know that their borrowers are reliable and punctual.

     While one late payment won’t harm a credit report terribly, a pattern of tardiness most definitely will.  Life happens.  We should not let one late payment discourage us.  Over time, the score will come back up as long as payments are regularly on time.

Total debt owed

     A high percentage of debt will cause a lender to shy away from a potential borrower.  If a borrower tends to use the majority of his or her available credit, they appear to be spending much more than their current income can afford.  That is not a good sign.

     It is best to keep the usage of all credit accounts at or below 40%.  If the usage amount is higher, we should work on paying them down as quickly as is possible.

Length of history

     The longer the time since a borrower first established credit, the better.  A long credit history gives a creditor a better idea of a borrower’s ability to pay.

     Even if we don’t use our older credit accounts often, it is a good idea to keep them open and to use them to reflect some activity on the accounts.

New accounts

     Opening new credit accounts can hurt a credit score.  A creditor does not want to feel that they have to compete with too many other creditors for a borrower’s discretionary dollars.

     We should avoid opening too many new accounts.  Also, we should be careful about closing too many of the accounts that we currently have open.  Closing accounts can affect the credit score as well.

Types of accounts

     There are two main types of accounts – installment accounts and revolving accounts.

     Installment accounts are loans that last for a given amount of time, such as a mortgage or a car loan.  Once principal is paid, it cannot be re-borrowed.  The account is closed when the balance is paid off.

     Revolving accounts are loans that don’t have a specific expiration date, such as a credit card.  The amount borrowed can be continually paid off and re-borrowed.  The account is not automatically closed when there is no balance due.

Monitoring our credit reports

     It is important to check our credit reports on a regular basis.  Once a year should help ensure that nothing unusual is happening with the accounts.  It encourages us to observe our spending habits and identify ways to improve our credit and our score.