Reuters Money

A silver lining: Credit cards buffered from rate hikes

With the downward plunge of the stock markets and the potential for interest-rate hikes following the downgrade of U.S. debt, consumers are understandably worried about their own interest-rates going up. But one bit of good news in all this volatility is that credit cards are somewhat insulated, for right now.

That’s “somewhat” because the protections are for what you’ve already spent and not what you’re going to spend going forward.

Banks have moved most credit card holders to variable interest rates, so it would seem the impact of any rate hike would be devastating and immediate. But ”consumers have new protections against sudden rate hikes, thanks to the credit card reform law,” says Dan Ray, editor-in-chief of CreditCards.com. The good news is that consumers have some time to plan ahead in case rates do jump.

First of all, any rate hikes that would happen would not affect existing balances, only new charges, thanks to the changes in 2009. (TransUnion, the credit reporting giant, says the average credit card balance in the U.S. is about $4,700.)

Secondly, there will be some lag in rates for consumers going up because rate hikes are tied to the prime rate, which is driven by the Federal Reserve, not the markets. But there is some bad news, too, because banks have pushed their customer to variable rates, and that means that any rate hike that does kick in will hit right away for new charges. Banks can also increase the margin of how much above the prime rate they will charge you, as long as they give you 45 days warning.

So, if your finances can’t handle a rate increase, the prevailing advice from credit experts like Bill Hardekopf, founder of LowCards.com, is to stop spending so you’ll know that your existing balance is locked in at the current rate.

Ray from CreditCards.com says, “It’s important to assess and plan. If you’re carrying a large amount of card debt, use a credit card calculator and play some what-if scenarios. Could you afford the payments if rates jumped, say, 5 percentage points?”

Consumers buy the wrong credit scores, new agency warns

At least some of the millions and millions of dollars that consumers shell out to buy their credit scores could be misspent, and possibly even damaging, the Consumer Financial Protection Bureau suggested in a report released today.

Consumers spend more than $1 billion a year buying credit reports and credit scores from credit rating agencies or other online scoring sites, the study said.

But “he or she will often receive a score that will not be the same score used by a lender to evaluate the consumer’s creditworthiness,” said the report, released two days before CFPB’s official launch as an agency. “It is important to note that many of the credit scores sold to lenders are not offered for sale to consumers.”

The downside of that? Besides wasting money on the wrong score, a consumer could make costly financial choices based on bad information. For example, if the consumer thought her credit was better than the lender did, she might spend time and money applying for loans for which she doesn’t qualify. If she thought her credit score was worse, she might not try for the best credit card or mortgage, thinking she wouldn’t qualify for it.

Some of that problem may go away soon. Beginning on July 21, lenders will be required to share the credit scores they use with consumers who get turned down for credit. But that won’t really help consumers who want to review (and possibly improve) their credit scores in the months leading up to a big credit application.

For them, there’s some takeaway from the CFPB report, as follows:

– If you’re going to buy a score, buy one that lenders actually use. The most commonly used credit scores are the FICO scores (available at myfico.com), but even the score you purchase there can differ from the one a particular lender is using, because there are different FICO score models, says the CFPB report.

New free credit scores: What you need to know now

There’s an irony about the new credit score disclosure rules issued by the Federal Reserve Board on July 6, and this is it: Would-be borrowers who are most likely to get their credit scores for free are still the people who may find it advantageous to buy their scores.

The borrowers who won’t get their scores may find they don’t need to buy them, either.

That’s because the rules require lenders to supply potential borrowers with their scores if they are denied credit or offered less favorable terms because of those scores. Starting on July 21, scorned applicants for credit cards, student loans and auto loans will see their scores.

But learning after you apply for a loan that there was a problem with your credit score isn’t that much help, is it? People who know that their credit reputation may be marginal will have to figure out a way to get their scores early enough that they have time to nudge them up before putting in those loan applications.

Here’s what you’ll need to consider as the new rules become effective:

If you get a score, it isn’t necessarily bad news. Some lenders may opt to send score reports to all of their applicants, because that is a less complex way to comply with the regulations, said Nessa Feddis of the American Bankers Association. So simply getting a score report won’t necessarily indicate that you received a worse deal than any other applicant.

Your credit report may be more important than your score. You already are allowed to get your credit report for free, and that’s where all the important facts of your credit history are located. The data in your credit report provides the basis for those credit scores. Everyone should regularly check their credit reports regularly, to make sure they are error-free. To do that, go to the official website, AnnualCreditReport.com. There you’ll find links to your reports at the three big credit reporting agencies: Experian, Equifax and TransUnion. If you’re getting ready to borrow big — say buy a car or refinance your home — get all three at once. If not, you may find it more useful to get one every four months, rotating, because you’re allowed one free peek a year at each one.

Why are credit scores such a mystery?

Do you know how your credit score is calculated?

Most people don’t because it’s a trade secret, and the private firms that collect credit data are poorly regulated. You have better chance of reading classified U.S. State Department cables on Wikileaks.

It’s troubling that your so-called “FICO” score, which measures your ability to pay back loans and maintain credit, is such a black box. This one number can determine not only your ability to get a mortgage or installment loan, but how much interest you’ll pay over time.

How important is your FICO score? Some 90 percent of banks use it in determining your finance charges. The lower your score, the higher the interest rate. (The highest-possible FICO score is 850, but even people with stellar credit don’t tend to exceed 825.)

On a four-year, $20,000 auto loan, a 740 FICO means you’ll pay $139 less each month over someone with a 620 score. Over the life of the loan, that’s real money: $6,672, according to myfico.com, which can send you your free score.

Potential employers and insurance companies also check credit scores, so your FICO is a keystone to your future security as well.

How is your FICO determined? Only a handful of employees at the Minneapolis-based Fair Isaac Corp. know and they won’t tell you — or government regulators. Then how do you know you’re getting a fair assessment of your credit practices? You don’t. You have to trust them.

Need a loan? 4 tips to improve your debt health

You’re young, ready to start a family and make the most significant investment of your life — the purchase of your first home. You’ve saved for a sizable down payment, but have you assessed your debt health?

The Great Recession has driven home the perils of plastic dependency, yet the average credit card debt per household in the U.S. is $14,750, according to CreditCards.com. And, in March alone, there were 144,657 consumer bankruptcy filings, up 41 percent from February’s total of 102,686.

“Right now, in this economy, credit is essential to getting a mortgage. There are different kinds of mortgages, but credit is a huge factor, along with the value of the property and your income,” says Tracy Becker, author of the Credit Solutions Kit and founder of credit restoration company North Shore Advisory.

Debtscore.com — a free financial tool developed by oweing.com — is designed to take the guess work out of assessing your debt health and help “borrowers understand for the first time how much debt is appropriate for their age, income and educational level.”

A debt-to-income ratio — the number used by many lenders to assess loan candidates — doesn’t adjust according to age, whereas this tool grades your debt health more strictly as you get older, taking into account your earning power through the years, JB Orecchia, CEO of oweing.com and former executive vice president of marketing for freecreditreport.com, says.

“The main need for the service was we saw people were paying the minimum payments on their bills and they weren’t making any headway in terms of paying down their debt and they also didn’t know exactly where to start,” Orecchia says.

A credit score tells you what you can borrow whereas a debt score tells you what you should borrow. Everyone is entitled to a free annual credit report from each of the three nationwide credit agencies: Experian, Equifax and TransUnion. Log on to annualcreditreport.com for your quarterly update.

What you need to know now about credit scores

Consumers may think they know all about credit scores, but they don’t, a key advocacy group has found.

“The bad news is that consumer knowledge has lagged behind recent changes in the credit score marketplace,” Stephen Brobeck, executive director of the Consumer Federation of America, told reporters on Monday, Feb. 28.  The Consumer Federation joined with VantageScore Solutions, a credit scoring company, to survey consumers’ current knowledge about credit scoring. On average, consumers scored a barely passing 60 percent.

Lenders, landlords, employers and insurance companies all use these automated scoring systems to assess the riskiness of their potential customers, so having a low credit score can cost you an apartment, an insurance policy, a mortgage loan, or several thousands of dollars in higher interest costs.  But the whole credit-scoring scene has been changing, because of better technology, more competition, and a punishing economic slowdown that has affected the scores of many, if not most borrowers.

The consumers  surveyed were largely unaware of just how much a bad score could cost them. For example, a borrower with a bad credit score could end up paying more than $5,000 in extra interest on a $20,000, 5-year car loan, according to the survey. Want to test your own knowledge? Check out the survey, posted on a new site, CreditScoreQuiz.org.

Here’s what you should know about credit scores now:

There are lots of credit scores.

A credit score is created when an algorithm is applied to the data in your credit file. With three major credit reporting companies — Experian, TransUnion and Equifax – all keeping customer files, and more than one scoring company providing algorithms, that’s a lot of scores right there. On top of that, lenders and other end users often buy or develop their own specialized algorithms to assess their customers.

What mortgage brokers don’t tell you: Hidden penalties abound

There’s a host of information a mortgage broker or banker won’t tell you up front that may increase the cost of your financing.

You could pay much more on a mortgage than your initial quote rate based on a rating system used by government mortgage insurers Fannie Mae and Freddie Mac. Brokers and bankers rarely tell you this coming in the door. They want to lock you in to a loan as soon as possible. With rates rising, this is really important to know.

In the wake of the biggest real estate meltdown in American history, the devil’s in the details when you apply for a loan. This hidden rating system will penalize you with a higher rate if your credit score is low or you apply for certain types of loans. It’s being employed by Fannie Mae and Freddie Mac, the government’s captive mortgage entities, which account for about 80 percent of new loans now.

As of January 1, mortgage brokers and bankers have to tell you that you may not get the best rate if your credit report is flawed, although they may not give you essential details up front on what else could bump up your finance rate.

You need to ask about how you will fare in the Fannie/Freddie “risk-based pricing” regime, which is basically a computer-run scoring matrix run by your banker. Here are some factors that could raise your cost of credit:

• Credit scores (based on the FICO system) below 740.
• High loan-to-value ratios (the percentage of the property’s value that’s mortgaged). The more equity you have or the more money you put down, the lower your rate.
• Adjustable-rate, Interest-only or 40-year loans.
• Cash-out refinancings.
• Investment properties.
• Condominiums and cooperatives.
• Manufactured homes.
• Multiple-unit properties.

The risk-based pricing program evaluates the type of loan, your credit score and loan-to-value ratio and determine what “add-ons” will boost your quoted rate, if any.

How your credit score can hurt you

By Toddi Gutner

While it helps to know the actual number that represents your creditworthiness or the likelihood that you’ll repay your debts, people often find out what comprises and affects their credit score long after they should. Your credit score is the determining factor that banks use to set your mortgage rates, car loans and credit card terms. For that reason along with making sure your credit report is accurate comprises the two main reasons to keep tabs on your credit score.

A number of years ago, I was stunned to discover that when I opened up a new credit card account, my fairly high credit score dropped.

Indeed, “opening a new credit card account with a $2,500 limit can knock your score by as much as 52 points and increasing a credit card balance by $2,000 can lower your score by as much as 68 points,” says Carrie Coghil, director of consumer education for FreeScore.com, a credit monitoring agency. To avoid being stuck in that scenario, consumers should arm themselves with a few facts.

Get your credit report. Since 2005, the federal Fair Credit Reporting Act requires that U.S. consumers be entitled to one free credit report every 12 months from each of the nationwide consumer report reporting agencies—TransUnion, Experian and Equifax—only through www.annualcreditreport.com (1-877-322-8228). You can request all three at the same time or one every four months to monitor any changes throughout the year.

Most credit scores are based upon a Fair Issac Corporation (FICO) score that goes from 300 (barely breathing) to 850 (perfect).  Everyone has a different FICO score from each credit bureau. These FICO scores often vary because of difference in the data on the credit reports from each agency. A 100-point difference in your FICO score could mean over $40,000 extra in interest payments over the life of a 30-year mortgage on a $300,000 home loan, according to myfico.com. Other options will provide a more comprehensive report but for a fee.

Understand the number. When credit agencies calculate your credit score they are adding and subtracting points based on a number of factors—each weighted differently. Your payment history contributes 35 percent of your score, the amount you owe is 30 percent, your credit history contributes 15 percent and 10 percent is attributed to newly opened credit. Finally, another 10 percent goes to the types of credit you carry.