Your Credit Report and Your Credit Score

Borrowing money in today's world is a lot more complicated than it used to be. Nowdays, you have a permanent credit history that follows you wherever you go. Banks and other credit issuers have a wide variety of options to evaluate your credit worthiness, and how much risk will be involved if they were to give you a loan.

When you decide to borrow money for a car, a house, or sign up for a new credit card, the issuer has the option to request and view your credit report and/or your credit score.

Your credit report is a detailed listing of your past and current credit activity. There are three main credit bureaus (TransUnion, Experian, and Equifax) that collect and report this information about you. Your credit report can contain several years worth of credit history, up to the number of years that is allowed by law. It is important for you to review your credit report regularly, looking for and challenging incorrect information. Because your credit report can be reviewed by anyone issuing you credit or offering you employment, you need to keep your credit report as accurate as possible. You can obtain your credit report once a year and free of charge by going to AnnualCreditReport.com.

Your credit score, on the other hand, is a calculated number based on your credit history. There are several types of credit scores, but the most popular scores are the FICO score and the VantageScore. Each score is calculated by proprietary algorithm (math formula). The FICO score is a number between 300 and 850, that a credit issuer (whether human or software) can quickly use to determine a person's credit worthiness. The Fair Issac Corporation has published general guidelines that determine a person's FICO score (see the Credit score article on Wikipedia for more information). Thirty percent of a person's FICO score calculation is determined their credit utilization (how much credit they have available on revolving credit, verses how much outstanding debt they have on those lines of credit). The VantageScore is similar to the FICO score, except that it is produced by the three credit bureaus. Its score has a range of 501 - 990. It uses a similar algorithm with a credit utilization of 23% being used to determine a person's score.

While it is important to regularly review and maintain your credit report, it is not important to make changes to your lifestyle and credit habits in order to maintain or raise your credit score. Your credit score is not an indication of wealth, but an indication that you can manage debt and the interest that comes with debt.

If you begin to live a more frugal lifestyle by paying off and closing your available lines of credit, your credit score will most likely drop. Back in 2006, I had a credit score of 750. Today, because earlier this year I paid off and closed a car loan and a credit card account, it has most likely dropped. No worries, when my wife and I apply for a new mortgage (the only debt we are willing to take on in the future), we'll find a lender that does manual underwriting.

Manual underwriting requires the lender to review your financial situation, including your credit report, your assets, and your liabilities. Because our only liability is our current mortgage (before we buy a new house we plan on selling our current house) we would have zero liabilities, and be in a great position to take on a new mortgage.

What are your experiences with credit reports and credit scores? Do you believe maintaining your credit score is important to your financial health? Please post in the comments below.

Wants vs Needs

Our inner child says 'I want it, I want it, I want it!' Our outer adult, in turn, says the item is not a need, and we have other, more important needs right now. We all feel these conflicts between our wants and needs.

Nearly all of us have a limited amount of spending money, and we cannot always fulfill all of our needs, let alone all of our wants.

Let's define these two terms:

• A want is an item or service that you could live without, whether temporarily or permanently. For example, a want could be a newer, larger TV.
• A need, on the other hand, is an item or service that is required to allow you to maintain your health and well-being (food, medicine, healthcare, insurance, etc), have a place to live (your home or apartment), household services (electricity, phone, etc) and transportation (a car to get to and from work). Some have other needs, such as a cell phone if they work outside.

Many of us (I'm guilty of this) will rationalize a new purchase and feel that the item which was a want yesterday is now a need, and should be purchased immediately.

In order to control my spending on wants, I've come up with the following test for determining when an item or service is really a need.

Ask someone (your spouse, a friend, a sibling, etc) the following question: Based on what you know of my financial situation, is this item (or service) a need, or is this item something that I can live without, at least for now? If they answer that it is a need, you should probably acquire it as soon as possible. If they answer that it is a want, you should probably wait to acquire it until you are in a better financial situation. It's ok to acquire wants, but only after you have a stable financial situation and can afford the item or service.

As I continue to ask my wife this question for each new thing that I think I need, counseling with her will help me keep my priorities straight and keep my spending under control.

Some of My Favorite Personal Finance Books

Over the last few years, I've probably read a couple of dozen personal finance books. Some have been excellent, while others were not so. Here are my favorites, grouped by author:

Elizabeth Warren and Amelia Warren Tyagi

• The Two Income Trap - Compares and contrasts single income households and two income households, and how two incomes in some cases causes us to spend more
  
• All Your Worth - Describes how to set up a spending plan (budget), pay off "Steal From Tomorrow Debt," and save
  

Dave Ramsey

• The Total Money Makeover - Explains many myths and facts about credit (debt), lists his 7 steps for becoming financially secure, contains many testimonials of people as they work on his steps
  

Thomas J. Stanley

• Stop Acting Rich - Explains how there are few people who look rich and actually are rich, but many more people who try to look rich and live in expensive neighborhoods that are not rich
  
• The Millionaire Mind - Research on people who have a net worth of ten million dollars or more, explains why it is more profitable to spend time on tasks that could have a future return on investment (writing books), rather than things that pay out only once (building houses)
• The Millionaire Next Door - Explains how he found that most self-made millionaires live in well-established, middle-income neighborhoods, stay married, take on little (if any) debt, drive paid-for cars, and live well-beneath their income

Mary Hunt

• Debt-Proof Living - Basics of budgeting and setting up a "Freedom Account" to save for larger purchases

James D. Scurlock

• Maxed Out - Describes the ill-effects of living on credit, with plenty of real-life stories.

Most of these books have been available at my local library. If your interest is in getting and staying out of debt, I recommend picking up one of the books above. Do you have a favorite? If so, please post below.

Why Does a New Car Lose Value So Quickly?

We all know that a new car loses value the minute you drive it off the car lot, but why? Well, there are a number of reasons:

• New cars are sold at or near their manufacturer's suggested retail price. This includes the cost to manufacture, ship, warehouse and sell the car. The dealer purchased the new car at a specific price, which, if they wish to make a profit, they must sell to you at a higher price.
• Just like any other mass-produced product (i.e. electronics and appliances), once you open and use the item, it is no longer worth its original value when a new product is still available.
• Many people prefer to be the original owner, and are willing to pay a premium for that privilege. Once a car has a used label, it will be overlooked by shoppers willing to pay full price for a new car.
• There is the perception that new cars are more reliable, while an old car is going to leave you stranded on the side of the highway on any given day. The reality is that new and old cars get flat tires, and their engines will seize without regular maintenance. Because of this perception, many people will blindly trade up at the dealership, trading in their old car for less than it is actually worth.
  

As you can see, there are many reasons that a car loses value. What are your experiences with buying and selling new and used cars? Please post in the comments below.

Why Should I Avoid Debt?

Why should I avoid debt? Of the dozens of personal finance books that I have read, most describe how to get out of debt, but few give good reasons why a person should avoid debt in the first place. Earlier this year, my wife and I became debt free (except for our house). In January 2009, we decided that not only were we going to pay off our last debt (our car), but that we were going to run our household without taking on any new debt, and stay debt-free.
In July 2009, we paid off our last debt, and immediately began putting money into savings. In November we purchased a piece of furniture (a king sized bed) for $1700, in cash. What satisfaction we received from saving and purchasing the furniture without any interest payments.
By paying cash, we avoided the following:

• Spending future income: we could have decided to sign up for future monthly payments that would have tied up a percentage of our future income
• Paying for the privilege of borrowing money: the creditor could have charged us a ridiculous interest rate (most likely 19% or more), meaning that the bed, if paid off in the agreed amount of time, would end up costing $2023 ($1700 + $323 in interest payments)
• Risk: if for some reason we couldn't make the payment one month, the financing company could repossess the item and/or begin contacting us to collect on the debt
• Negative items on our credit report: because we didn't establish a line of credit with the furniture store, there is zero chance that a negative item will show up on our credit report because of this transaction
  

Because we paid for the item in full, we have avoided the issues outlined above. Planning ahead, shopping around, looking for the best deal, and saving up beforehand will allow you to pay in cash and avoid future debts. What are your experiences with avoiding debt? Please respond in the comments below.

Blow Money

When budgeting for your family, one of the most important categories you can include is the Blow category. This is your personal "miscellaneous items" category, which gives you the freedom to spent money spontaneously and spend money on yourself. In our household budget, we have four blow categories, one for my wife, one for each of our daughters (we have 2 kids), and one for me. We have decided to be generous with this blow category, because it also serves as a personal clothing budget.
For some of our household budget categories, we withdraw cash at the beginning of the month for categories, such as food, where we would walk into a store to spend the money. This allows us to easily see how much money is left in our budget for specific categories at the end of the month. Each of these cash budget items has its own envelope. When we go to buy food, we take the food envelope or a few bills from the food envelope with us.
I usually carry $20 or $40 of blow money in my wallet. This gives me the freedom to go out to lunch during the week. It gives me the option to pick up milk on the way home if I don't have our food envelope with me. It allows me to buy a new music cd or electronic device.
As stated earlier, our kids have their own blow categories, but that money is not an allowance. Their blow money is more of a clothing budget. When one of them needs clothes, that's the budget category the money comes from.
One thing that the blow category does well is it helps you keep the rest of your budget on track. For example, if there are a couple of days left until your next paycheck and your entertainment budget envelope is empty, and you haven't spent all of your blow money, you can still go out to the movies.
What are your experiences with your blow money? Please post in the comments below.

Top Ten Reasons to Get Rid of Your Credit Cards

In the style of "The Tonight Show with David Letterman," I have put together a list of reasons to get rid of your credit cards. Here's my list:

10. The issuer can change the interest rate at any time (not only on future purchases, but also on past purchases)
9. We're instructed by church leaders to stay out of debt, but each time you use a credit card you create new debt
8. Paying your mortgage, rent and utilities on time is a better way to establish credit
7. It provides a false sense of security (debit cards provide the same fraud protection, cash provides 100% fraud protection)
6. It's easy to hide expenses from yourself and your spouse
5. It's easier to break the budget when you're spending someone else's money
4. You're spending future income on things you want today
3. The issuer can drop your available credit line, and if you're maxed out, this could trigger overdraft fees
2. The issuer counts on you occasionally paying late and triggering additional fees
1. A credit card should not be a substitute for an emergency fund

Once my wife and I got rid of our last credit card, we felt a sense of independence, relief, and control. Do you have any additional items that could be added to this list? If so please post in the comments below.

How and Why My Family Got Out of Debt

Based on personal observation, there are two schools of thought for consumer debt (car loans, credit cards, HELOCs, etc). One is a need it now mentality, if I can make the monthly payments, I will be ok. The other is the idea that I can get along without the item until I have enough saved, and avoid the interest payments by buying it now. As of the last couple of years, my wife and I have chosen to delay our wants and save for those items.
Since we paid off our last consumer debt (our mortgage is our only debt), my wife and I have been discussing the reasons that we made that choice. Listed below are the hows and whys of our choice, ideas that we've held to while getting out of debt and solidifying since we became debt free.

Why we got out of debt

• We hated the idea of paying interest for things that had little value
• We wanted to save more money
• We wanted to reduce our financial stress levels
• We hated the idea that if a payment was late, the financing company could charge us late fees
• We hated the idea that if for some reason we couldn't make the payments on our family car, the repo man could show up and haul it off
  
• We hated the fact that on our credit cards, the bank could change the terms of service (interest rate, when they could start charging interest, etc) at any time, and only with 25 days written notice

How we got out of debt

• We live on a cash budget, which helps us control our spending
  
• We gave up our personal blow money categories to speed up our debt payment process
• We set a goal in December, 2008 to be debt free by August of 2009. By staying on top of our finances, we paid off the debt in June, three months earlier than our original goal.
• We got fired up, and regularly reviewed our spending. When we had money left over at the end of the month in a budget category, we made adjustments the next month and the difference went towards debt payments.
• We told others about our goals to become debt free
• We got our young kids involved by saying things like "when we've paid off the car, then we can go out to eat," and "when the car is ours, no one can take it from us"
• We got rid of our credit cards and closed those accounts
• We skipped expensive family vacations
• We had cash only birthdays and Christmases (I only received about $30 worth of gifts from my wife and kids last Christmas, and it was one of my favorite Christmases yet)

Since we paid off the debt in June, we've been able to set aside savings for new furniture and emergencies. It's a great feeling to know that we can keep most of my paychecks every month. If you carry debt, what are your plans to get out? Please post comments below.

Our Auto Loan: An Analysis

Last Friday we paid off our last debt, our auto loan. Have there been any regrets for paying it off early? Not at all. In fact, it's been a relief.

After I paid off the loan I logged in to the Chase website to make sure that the account had been closed. On the account summary page, I found many things that were wrong with this (and I assume would be wrong with many other auto loans).

The following screenshot is from our Chase account. I'm going to step you through this summary line by line.

1. Outstanding principal balance: $0.00 (One of two positive items in this list)


2. Amount financed: $18,622.72 (I remember taking an advertisement with us to the dealership, which listed the vehicle for around $14,000 or $15,000, so the other $3000 must have been taxes, licensing and fees)


3. APR: 7.29% (We got a pre-approval for a similar rate at wells Fargo before we went to the dealership to test drive and buy this car. We financed through the dealership, but, as I'll explain below, even 7% is a lot to pay in interest on the amount that we financed)


4. Original term (months): 66 (Five and a half years is a long time to finance a car, many people replace their cars in less than 5 years and roll their existing loan into a new loan. We paid off this car in 35 months)


5. Contract date: 7/14/2006 (We bought the car just less than 3 years ago)


6. Account closed date: 6/21/2009 (The second positive item)


7. Interest paid YTD (year to date): $247.44 (This is $247 that could have gone to something better, such as building up our food storage, or building savings)


8. Total interest paid: $2,980.91 (This is the saddest line on this summary. It cost us almost $3000 in interest. Add the taxes, license and fees ($3000), and that's $6000 that could have been put to better use. Of course, buying another car costs in terms of licensing and taxes, but since I won't go and look for the original paperwork, who knows how much the dealership charged for fees)

In summary, we paid over $21,000 over the last three years for the privilege to drive this car. The car's current private sale value is about $8,500. We lost about $12500 (21000 - 8500) in this deal.

Based on this analysis, will we finance our next car? You can safely bet no.

What are your opinions on auto financing? Leave your comments below.

We're Debt Free!!

We did it. We finally paid off our last debt: our auto loan. Last January, my wife and I had discussed finally paying off the our loan. We sat down and determined that August would be a reasonable timeframe where we could pay it off. As the months went on, we found more money left at the end of the month than we had originally planned. We would set that extra money aside into our savings account, just to make sure that we could cover any budget items that we must have forgotten about. Most of the time, my next paycheck came and we had a little bit more to set aside in the savings account. After attending Dave Ramsey's Live Event in May, we got the extra push we needed to keep $1000 in savings and use the rest to pay down the loan.

On June 5th, we were able to pay the loan down to $1050. The next two weeks were some of the longest weeks that I can remember, for two reasons: 1) we've been waiting for this day for a while, and 2) we got so excited about paying down the loan that we had to make our budget stretch farther than we had anticipated.

This morning I walked into one of the branches of Chase Bank. The first person I saw when I walked in was a banker. I stated that I was there to pay off my auto loan, and for a second it looked like he was trying to remember how to complete a payoff. He took me to his desk, looked up my account, and wrote down the payoff amount. I wrote a check for that amount, and he said that it would take about a week for the payoff letter and the title to be sent to my house. I also got the phone number of a Chase Auto Finance department so that I could call and cancel the automatic payments from our checking account.

I walked out of that bank and it felt like a weight had been lifted from my shoulders. I called my wife and told her the news. When I got home that evening, we celebrated with pizza and roasted marshmallows (no credit cards this time!).

Now our focus is to put away 6 months worth of expenses. We estimate we could live on about $3000 per month. We plan on taking a vacation or two and finishing our emergency fund by next summer.

What's in Your Wallet?

My wife and I finally did it. We got rid of our last credit card. Last February, we got a love letter from Capital One. In that letter, they stated that they were going to raise our interest rate from 8% to 17% for no apparent reason. We used the card occasionally, and haven't carried a monthly balance or paid interest on the card for a couple of years.

Inspired by Dave Ramsey's books and website, we decided we're going to stop borrowing other people's money and thus being required to play by their rules.



This morning I called Capital One and closed the joint account. This evening, we decided to light a fire in our backyard fire pit and roast some marshmallows and credit cards. The video above is one of our credit cards. It didn't give up easily: no bright flames or puffs of smoke, just a slow, smoldering death.

As a substitute, we have two checking accounts, one at a bank and one at a credit union. We'll keep a few hundred dollars in one of them for the occasional online purchase, and the other one will continue to be used for our normal day to day purchases.

From now on, we will be planning our purchases, spending money we already have, and we will no longer have any worries about whether the last credit card bill was paid on time.

But, you may ask, what about EMERGENCIES? How will we survive if something unexpected comes up? As it stands right now, we have almost as much in savings as the our credit limit on that card. If an emergency came up, give me two minutes on the computer to transfer the money into my savings account, and I'll pay for the emergency with my debit card.

Have you considered getting rid of your credit card(s)? Please post your comments below.

Comprehensive Auto Insurance: Is It Worth It?

Since my wife and I got married, we've had 2 automobiles. We've always carried comprehensive auto insurance on the car that was worth the most, and only carried liability on the cheaper car. Our reasoning was that if we caused an accident in the cheaper car, liability insurance would cover the costs associated with replacing or fixing the other person's property, and we would be able to get by until we could replace our car.
My previous job was about 10 miles from home, and there were several guys who live close to me who also work at the same office. We regularly carpooled, and if I had car trouble, I still had a way to get to work.
I recently started a new job that is about 25 miles away, and no longer carpool. I drive the cheaper car, and realized that if I got in an accident, we would be in a bind because we're currently focused on paying off our more expensive car.
I called our auto insurance company to find out what it would cost to add comprehensive and collision insurance. Based on the age of the car (it's a 2000 Plymouth Neon, worth a couple of thousand dollars), they said it would only cost an additional $100 per year. I promptly sent in my payment. This upgrade added towing assistance and car rental fees if I am involved in an accident. I now have peace of mind that I can still get to work if my cheaper car is involved in an accident.
What are your thoughts on carrying comprehensive versus liability insurance? Leave your comments below.