You’ve probably been concerned at one time or another with your credit worthiness: the somewhat squishy way that lenders determine whether you’re going to repay, for example, a home loan. I say “squishy” because ultimately, these decisions are made by human beings in a temporal landscape. We bought our house in June 2007, and if we had tried just one month later, when rules were stricter, it likely wouldn’t have happened.

Nobody is allowed to know the exact algorithm that produces your credit score, but even if we had access, it probably wouldn’t be the same from month to month.

One thing that we thought we knew was that if you have too many open accounts, it can hurt your credit score. Now, a product support manager for Fair Isaac Corp. (where the term “FICO” comes from) is answering questions at BankRate.com, and in part of the answer to the first question, he replies:

It’s just not true that you can have too much available credit. That by itself is never a negative with the score … There really is never any good reason to close an account.

You’ll probably want to read the rest of the article to get all the specifics, and see what else he says on what does and doesn’t hurt your credit score.

TV Girl wrote into Consumerism Commentary (and a few other blogs, so I expect to see responses elsewhere) with the following question about credit freezes:

I’ve been listening to Dave Ramsey talk on his radio show about freezing your credit report, but I haven’t heard much (if anything) about this issue in the pf blogosphere. He seems to think it’s the best thing since sliced bread, but I’m wondering what your opinions are. What are the pros and cons? In what circumstances would you do this or not?

A credit freeze will let the credit reporting bureaus know that your personal information should not be shared with any companies that place requests. This will hinder your ability to sign up for a new credit card or take out a mortgage. If you’re a full follower of Dave Ramsey, then that shouldn’t inconvenience you at all. Dave Ramsey preaches avoidance of credit and debt of all forms, buying only what you can afford with cash. Is there any danger to having your credit reporting frozen? I don’t think there is any danger.

Those who use access to credit to their advantage, and hopefully do so responsibly, will be hindered by a credit freeze. If you know you’ll be shopping for a mortgage or taking advantage of 0% APR credit card offers, then a credit freeze is not for you. Your ability to sign up for deals which allow you to pay for today’s expenses with tomorrow’s money (which uses inflation to your favor as long as you avoid fees and interest charges) will be hindered by a credit freeze.

The primary customers, the persons for whom credit freezes are meant to protect, are those who believe they are or might be the victim of identity theft. A credit freeze will disallow anyone from opening credit in your name. So if somehow an individual ends up with your social security number and other personal information, with a credit freeze, the perpetrator will not be able to successfully apply for credit cards, rent an apartment, or finance the purchase of a car in your name. This is by far the biggest benefit.

On the other side of the argument, merchants don’t want consumers to have the option of freezing credit. The reason is simple: the inability to get instant credit means that merchants will sell less of their products. The possibility for a large purchase on impulse is effectively eliminated by credit freezes.

I understand Dave Ramsey’s point of view, but credit freezes are not for everyone, nor are they for every circumstance. I also believe that fears of identity theft are generally overblown. It’s a compelling story, so the media return to anecdotal stories of identity theft often. It’s also a money-making industry for security companies, so they have a vested interest in making the problem appear larger than it is.

It’s important to remember that a credit freeze is not a complete solution for preventing theft. When an existing credit card of yours is stolen, the thief can still make purchases regardless of the status of your credit report.

To see if you are eligible for credit freezes, check the Consumer Union’s Guide to Security Freeze Protection for the laws in your state.

As I do with any email I receive asking me for financial advice, I included a disclaimer. I am not a financial adviser—and while asking bloggers your financial questions may seem like a good idea, it does not replace doing your own research and speaking to unbiased financial experts. I started Consumerism Commentary, and Sasha later joined, not because we believe we have all the answers and the need to share them, but because there are many questions and blogging provides an opportunity for us to learn.

I’ve mentioned before that your income (or reported income) comes into play when you are offered credit. But wait! Your income isn’t considered when Fair Isaac Corporation calculates your credit score.

We were discussing qualifying for mortgages at the time, but recent article from Liz Pulliam Weston confirms that credit card companies use some scoring calculations beyond your credit score—and you do not have access to see how you rate.

Here are the 8 scores credit card issuers use for a variety of situations—whether to extend credit, what types of marketing to send, when to send your account to collections, etc.

• Response score: the likelihood you will respond to a credit offer.
• Application score: the favorability of your income, how long you’ve lived at your current address, how long you’ve worked for your employer, and other data entered on your application.
• Bankruptcy score: the likelihood you’ll declare bankruptcy.
• Revenue score: how much your account will earn the issuer (through interest fees, late fees, interchange fees, etc.)
• Attrition-risk score: the likelihood you’ll abandon your card.
• Behavior score: the reliability of your payments and whether you pay your balances off slowly, quickly, or completely every month.
• Transaction score: the likelihood of legitimacy for any individual transaction (that is, whether this particular charge is possibly fraudulent).

• Collection score: the ability to pay your delinquent account if sent to a collection agency.

  Numbers are meaningless without some kind of scale and guide to describe the meaning behind them. It would be even more helpful to see some statistics describing where other people stand on the scales to allow comparisons with other people. Unfortunately, the current situation doesn’t allow for this information to be shared.

  Want to see your numbers to see what your credit card issuers really think of you? You can’t; it’s a secret.

  8 Secret Scores That Lenders Keep [MSN Money]
  Image credit: marie-ll

I have two checking accounts. One is with Wachovia, which has been my main checking account (through bank mergers and acquisitions) for the last 15 years or so. The other is with ING Direct, which is a more recent development.

Both checking accounts have provided me with debit cards which can be used to access the accounts at ATMs or for purchases. Once I started getting my finances in order, I stopped using debit cards for purchases and started using credit cards. Some of the reasons for doing so are discussed in a recent MarketWatch article. Here are MarketWatch’s four reasons, plus one of my own.

Double funds tie-up. Gas stations pre-authorize your account before pumping and the bank places a hold on those funds. This hold does not disappear when the “true” charge is authorized. If you plan your checking account close to the hilt, which I used to do, this can result in unintended overdrafts. Now I have enough available funds to keep a buffer in my checking account, but I shouldn’t have to. Sometimes the pre-authorization hold is only $1, but some stations may re-authorize as much as $50. If you use a credit card, there is no “hold” and only the true charge affects your available balance.

Can’t dispute debits. MarketWatch notes that some banks have started to offer consumer protections for the debit cards, but they still don’t come close to what is offered for credit cards. Here’s an example from the article:

A friend of mine recently bought three bottles of her favorite Scotch in a Mexican airport duty-free shop. The shop didn’t deliver the goods to the plane before take-off, and she went home empty-handed. She was able to successfully dispute the charges. Good thing she used a credit card.

If she used a debit card, she would not have her money back in her account until the investigation was complete. That’s an unacceptable situation for me.

Can’t rent a car. This is probably the most basic argument against those who try to convince others that life would be better entirely without credit cards. You can’t rent a car with cash. You should be able to, and maybe there is a rental company somewhere that will allow debit cards for the initial deposit required for reserving a vehicle, but it’s incredibly uncommon.

Theft protection. The article points out that a the owner of a stolen credit card is liable only for $50, but the owner of a stolen debit card can be liable for much more—and if the card is used by a thief, the money will still be deducted from the true owner’s bank account pending the investigation. Take a look at this:

The bank has up to 10 business days—and up to 45 if an investigation is required—to restore your balance. And if you take more than 48 hours to report a lost card, your liability limit is $500, not $50. Worse yet, if you fail to report a loss within 60 days of a bank statement showing the fraudulent transaction, your loss is unlimited.

It’s definitely helpful to be on top of your finances and report stolen cards immediately, but these days, card numbers can be stolen without the owner’s knowledge and used in a number of places where no signature or PIN is necessary.

Here’s a reason of my own, not mentioned in the articles.

Rewards options. Right now, the ING Direct Debit Card is offering 1% cash back, but cash back rewards with debit cards are few and far between. You can do much better starting with these cash back credit cards. Of course, if you pay any interest or late fees at all, this reason quickly becomes invalid as the fees outweigh the rewards.

If you find that whether using debit cards or credit cards, you spend more than you should, the best option is to find a way to always have cash on hand and save the credit card for only when necessary (like reserving a rental car as mentioned above).

Do you prefer debit cards or credit cards? The only situation in which I can presume that use of a debit card is better than a credit card is if you will be concerned about your credit score in the short-term and you spend close to your credit limit on a monthly basis. Frequent debit card user may be able to explain other benefits that credit cards do not offer, so feel free to share.

One of the most common ways for young people, say teenagers, to build credit is to become an authorized user on one or more of their parents’ credit cards. This way, they immediately have a significant amount of available credit, and by the time they need a credit score after college, they might have a decent number.

Fair Isaac Company, the organization that calculates the official credit scores for the reporting bureaus, is eliminating this method of building credit. While this has been a great strategy for people—if you believe that “building credit” is necessary, anyway—there is one percent of customers who use this strategy in a less legitimate way.

Companies like instantcreditbuilders.com have created a marketplace by connecting those with bad credit with willing participants with good credit, for a fee. The bad credit customers pay a fee to those with the better history to be placed as an authorized user on their credit lines. In the past, this has benefited those with bad credit by increasing their score with no effect to the participants with good credit.

Starting in September, Fair Isaac will be changing the credit score formula, which I described recently, to disregard this piggybacking. Here’s a suggestion from Yahoo Finance on how to gain the same effect once the formula changes.

Families who employ piggybacking to help children or new spouses jump-start their credit have other ways of achieving their goal. Mr. Totaro says joint users on an account, like authorized users, get the benefit of the card’s entire history, but joint users are accountable for the debt on the card while authorized users are not. Additionally, family members with good histories can cosign loans to help loved ones secure credit.

For parents who want to teach their kids about responsible credit usage and want to give them a leg up which can help many years down the line when it’s time to qualify for a mortgage, there are still options. The options aren’t as good, however.

Photo credit: selvin

While the formula that Fair Isaac uses to determine your credit score is a closely-guarded secret, the company does provide an overview of what they use in the calculation.

Looking at these components, it becomes pretty clear what the company looks for when providing the best scores, which will assist in qualifying the borrower for the best interest rates.

Here is a chart based on information from Fair Isaac:

Your payment history has the most weight in the calculation, so the first piece of advice one might divine is to make your payments on time.

The second most important aspect is the amounts owed to lenders. Keep this number low in comparison to your total credit available. This isn’t a perfect calculation. For instance, Capital One doesn’t report your true available credit, so card holders are at a disadvantage in one of the most important components of their credit score.

FICO also stresses length of credit history. This is why it might be helpful to build a credit history as early as possible. But if this credit history is begun before the card holder has the mental capacity to or understanding to use credit properly, this strategy can backfire.

When calculating a credit score, Fair Isaac doesn’t want to see too many new credit lines. If you know you’re going to need a high credit score in the near future, say if you are applying for a mortgage, you may not want to open any new credit cards within six months or so before starting the application process. The exact figures are secret, but a six month window is probably safe.

The last component takes a look at the types of credit: unsecured credit card debt, automobile loans, mortgages, consumer finance, etc. FICO likes to see equal utilization of all types of credit.

The chart isn’t perfect. Bankruptcies aren’t included in the components listed by Fair Isaac, but a bankruptcy on record would severely damage your score. Also, while 35% of the total score is attributed to payment history, a poor payment history can affect more than 35% of your total score.

FICO actually computes different scores depending on the type of credit you are applying for. Additionally, each of the credit reporting bureaus calculate their own scores for their own purposes. In general, what’s good for one agency is good for the others.

The FICO Forum appears to be a good resource for anyone who wants to ask specific questions about their credit scores or their calculations, but as with anything, don’t just rely on one source of information.

A reader wrote to me with a question, in response to my entry regarding how Capital One credit cards hurt your credit score. She is concerned with Capital One’s bureau reporting tactics and their junk mail, but it’s her oldest account, so she doesn’t know if closing the account is the best thing to do.

I responded with some suggestions, but I’m wondering what advice readers may provide. Here is the text of her email. Read the rest of this article »

An item in today’s Marketplace Morning Report started out with this condemnation: Credit cards. Aren’t they evil? A convenient, maybe even necessary evil, perhaps, but such a temptation.

They reported that the Senate’s Banking, Housing, and Urban Affairs Committee heard testimonies from consumer advocates today who want to see more regulation of the credit card industry. According to the AP Report, the committee chair plans to crack down on the fees charged by the credit card companies and scrutinize the way they take advantage of members of the military.

The Senate committee heard representatives from credit card issues such as Capital One and J.P. Morgan Chase. If you are so inclined, you can watch the full hearing.

Eilzabeth Warren, a professor at Harvard Law School, testified this morning. She wrote about the hearing briefly on her blog, and I’m looking forward to the follow-up.

Also, check out The Secret History of the Credit Card, posted at Millionster.