1/26/2011 12:05 PM ET|
5 ways to be stupid about credit
What you think you know about your credit scores is probably wrong -- and that can cost you. Arm yourself against 5 common misconceptions.
The world of credit can be confusing, counterintuitive and strange. Trying to get a handle on how it all works isn't easy -- which may be why so many myths and misstatements about credit get passed along as fact.
The good news is that people who want to educate themselves about credit can do so by visiting sites like this one and many others, including Creditbloggers, myFICO and the Federal Trade Commission's site.
In the meantime, if you want to sound smart about credit, here are things you don't want to say.
Misstatement No. 1: "My credit score is 740."
You don't have one credit score -- you have many, and they change all the time based on the constantly shifting information in your credit reports.
The credit scores most lenders use are called FICO scores, which range from a low of 300 to a high of 850, and you have three of them at any given time -- one from each of the three major credit bureaus. Credit bureaus use the same basic FICO formulas to generate the scores they sell to lenders, although the FICO scores themselves can go by different names:
- At Equifax, they're called Beacon Scores.
- At Experian, they're known as the Experian/Fair Isaac Risk Model.
- At TransUnion, they're called Empirica.
If the credit score you get isn't called a FICO or one of the above names, it's not a FICO. You may be looking at a VantageScore, a competitor to the FICO, or at one of a credit bureau's in-house "consumer education scores" that aren't widely used by lenders and that may not be in the same ballpark as your FICOs.
You can buy two of your three FICOs from myFICO for $19.95. Experian, however, no longer sells FICO scores to consumers, although it still sells them to lenders. So the most accurate thing you can say is something like: "Last time I checked, my Equifax FICO was 740, and my TransUnion FICO was 735. And it's about time Experian started selling FICOs to consumers again!"
Misstatement No. 2: "Credit scores are debt lovers' scores."
If you don't understand much about how credit scores work, it may seem logical that they would reward people who pile on debt. But that's not necessarily the case.
You can get and keep good credit scores without ever paying a dime in interest or carrying debt. You simply need to have, and lightly use, two or three credit cards, paying the balances in full every month.
It's true that it's easier to achieve good scores if you have a mix of credit: revolving accounts (credit cards) and installment loans (a mortgage, auto loan or student loans, for example). But people who use credit accounts to dig themselves deeply into debt are unlikely to have good credit scores for long.
That's because credit-scoring formulas are extremely sensitive to how much of your available credit you're using at any time, particularly on revolving accounts. So if you max out your credit cards or even come close, you're likely to hurt your scores. (This is true, by the way, whether or not you pay your balance in full. The balance reported to the credit bureaus, and used in credit score calculations, is typically the balance from your most-recent statement, before you sent in your payment.)
Plus, anyone who takes on too much debt is likely to start missing payments. A single skipped payment can knock as much as 110 points off your FICO scores.
The key to having good credit scores is to have, and responsibly use, credit. Piling up debt isn't responsible, necessary or smart.
Misstatement No. 3: "Credit scores don't benefit consumers. They just help lenders squeeze more profits out of us."
There's a kernel of truth here. Credit scores were designed, wholly and entirely, to benefit lenders by helping them gauge the risk that you would default on a loan. Originally, you weren't even supposed to know that credit scores existed. Once upon a time, lenders were contractually obligated to keep them a secret.
But that doesn't mean the system has no benefit for individuals. Credit scores gave lenders the confidence to make credit more available -- and make it cheaper for those with good scores. That means if you're responsible with credit, you'll pay less for a loan than someone who has been less responsible. You won't have to cover the risk that the other guy will default.
Credit scoring is also pretty much colorblind. In the not-so-distant past, it was harder for women and people of color to get a loan. Discrimination hasn't entirely disappeared, but credit scores have gone a long way toward convincing bankers that it's unprofitable.
Misstatement No. 4: "I paid my old debts, but they're still showing on my credit reports."
Paying your debts doesn't erase them from your credit history. The credit bureaus can continue to report negative information for up to seven years and 180 days after an account first went delinquent. (Bankruptcies can be reported for up to 10 years.)
You may be able to persuade a collection agency to delete a collection account from your credit reports in exchange for payment. But you typically won't be able to erase what the original creditor reports about you, which means that the information that's most damaging to your credit scores -- the skipped payments and charge-off that occurred before the account was turned over to collections -- will remain on your reports for the full seven and a half years.
By the way, you shouldn't fall for a credit repair firm's pitch that it can erase true, negative information from your credit files. These outfits often flood the bureaus with disputes, but the vast majority of those disputes go nowhere, and the negative information remains on your files.
Misstatement No. 5: "If you don't pay your debts, you're stealing."
Theft is a crime. Owing money generally isn't.
There are exceptions, of course. If you rack up debt knowing full well you can't pay the bill, you're committing fraud. Refusing to pay the Internal Revenue Service (like actor Wesley Snipes) or court-ordered child support (like former NBA star Vernon Maxwell or hotel magnate Patrick Quinn) also can land you in jail.
But most people who owe debts they can't pay didn't start out intending to stiff their creditors. In fact, many people who struggle with debt wind up draining assets that would otherwise be protected from creditors, such as retirement accounts or home equity.
Most of us believe that skipping out on a debt you can afford to pay is morally wrong. Throwing in the towel on debts you can't pay, however, is sometimes the best of bad options.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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Congratulations to the new era!! Gas prices high...almost 4 dollars a gallon, trying to survive in getting to work with low wages...and your house has swelled up like a weed sprayed with weed be gone. Owe a lot more than the house is worth. There is a time and place to make every opportunity to pay your debt on time...every time. SORRY for all those who live a life of frugality. Saving till your 55/65 so you can retire...only to find out you have cancer or are wheel chair bound the rest of your life and cant enjoy your assets and having fun because you cant walk more than ten feet. PEOPLE listen! Enjoy life right now!! Go to vegas and go camping at least once every other weekend! Take the kids to both places and everywhere you go....they grow up to fast and will be out of the house before you know it!
Bail out of your house...walk away...from the house...drain your credit cards that are unsecured and pay off the secured items you want to keep...live life...and get rid of the vehicles you are upside down in. Once you are prepared to bail....the money you drained from a credit card..pay a Chapter 7 attorney! File chapter 7 bankruptcy!! Start from scratch! For me...I had an auto loan for a brand new truck three weeks after the bk was closed...I have four credit cards from the credit cards I filed BK on with failrly high credit limits unsecured...and start all over again. Banks are hurting that bad for your business!! Rent for two years...then think about buying later on. If you do this...you will enjoy life now and make other people pay for your debt....congratulations....the american way!!
What if you can not pay debt because you loose half your wages and your wife also lost her job and COBRA insurance cost $2000 per month and you are rejected for health insurance because you had cancer. Is it immoral then?
Not all people who claim bankruptcy started out to game the system.
My daughter and her husband had purchased a house that they could afford. Both she and her husband were working. A few months after they bought their house, he was diagnosed with RA and could no longer be a licensed mechanic. He could hardly stand for any length of time or work under a car so there went 1/2 their income.
My daughter was working so they were scraping by, 3 kids to support but made their bills. Then her company went bankrupt, so she started school full time. Unemployment was $387 a week, almost 1/2 of what she was making. Add that to what her husband had lost in wages and it was a reduction of about 60%. We were able to help out for a while. She got another job for 9 months, still going to school full time then her 2nd company went bankrupt.
Due to the financial stress, her husband left and went back to Canada leaving her with 3 kids to support and no child support since he was disabled. She was lucky that her church helped her out and we did as much as we could.
Now 3 years since this all started she is drowning in debt and about ready to give in. Can't sell the house they bought for $135,000. It is maybe worth 1/2 that even though it is in a good area.
She was able to get a modification on the first mortgage but not yet on the 2nd. Creditors call and are exceedingly rude so she just quit answering the phone, they won't listen that there is no money. So I probably will take her to a bankruptcy attorney and end the extra stress in her life.
She wants to pay her bills, but the job she has now doesn't pay them. In another year or 2 when she finally gets established in her IT career, things should be good. But what does she do until then? Not everyone who claims bankruptcy wants to.
Misstatement #5 is not a misstatement. It is morally wrong to not pay your debt. When you borrow money, you're borrowing money to pay that money back, no matter what. If you don't pay the money back, you're taking it. In other words, you're stealing it. A lender's money belongs to the lender, not to you. When companies or governments lose money from this theft, they have to make up for by means such as raising prices for everyone else. So when you commit bankruptcy, we pay for it. So unless you die unexpectedly and insurance and your assets can't pay the debt, or develop a permenant, totally INCAPICITATING medical condition that costs an extraordinary amount of money forever, you are stealing if you don't pay your debts.
This is not the best of bad options as Liz Weston states. This is either a bad option to skip out on your debt, or a good option to pay off your debt no matter what. Don't tell me you can't go on food stamps or move your family into a shelter or with relatives. There is no compromise. Lets stop reading the articles of compromisers who promote compromise.
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