How to examine the Credit Score and Reports

You may not know it (or care), but you probably have a personal credit
report and a credit score. Lenders examine your credit report and score
before granting you a loan or credit line.

Understanding what your credit data includes and means

A credit report contains information such as

Personal identifying information: Includes name, address, Social
Security number, and so on

Record of credit accounts: Details when each account was opened,
latest balance, payment history, and so on

Bankruptcy filings: If you’ve filed bankruptcy in recent years

Inquiries: Lists who has pulled your credit report because you’ve
applied for credit

Your credit score, which is not the same as your credit report, is a three-digit
score based on the report. Lenders use your credit score as a predictor of
your likelihood of defaulting on repaying your borrowings. As such, your
credit score has a major impact on whether a lender is willing to extend you a
particular loan and at what interest rate.

FICO is the leading credit score in the industry and was developed by Fair
Isaac and Company. FICO scores range from a low of 300 to a high of 850. As
with college entrance examinations such as the SAT, higher scores are better.
The higher your credit score, the lower your predicted likelihood of defaulting
on a loan. The “rate of credit delinquency” refers to the percentage of consumers 

who will become 90 days late or later in repaying a creditor within the next two 

years. As you can see in the chart, consumers with low credit scores have dramatically

higher rates of falling behind in their loans. Thus, low credit scorers are considered 

much riskier borrowers, and fewer lenders will be willing to offer you a given loan; 

those who do will charge you relatively high rates.

Obtaining your credit reports and score

Given the importance of your personal credit report, you may be pleased to
know that you’re entitled to receive a free copy of your credit report annually
from each of the three credit bureaus (Equifax, Experian, and TransUnion).
If you visit www.annualcreditreport.com, you can view and print copies
of your credit report information from each of the three credit agencies
(alternatively, call 877-322-8228 and have your reports mailed to you). 

After entering some personal data at the Web site, check the box indicating that
you want to obtain all three credit reports, as each report may have slightly
different information. You’ll then be directed to one of the three bureaus, and
after you finish verifying that you are who you claim to be at that site, you
can easily navigate back to annualcreditreport.com so you can continue
to the next agency’s site.

When you receive your reports, the best first step is to examine them for possible
mistakes (more in a moment regarding fixing problems in your reports).
I recently did that myself and found minor errors on two of the three reports.
It took me two minutes to correct one of the errors (by submitting a request
to that credit reporting agency’s Web site), and it took about half an hour to
get the other mistake fixed (a small doctor’s bill was erroneously listed as
unpaid and in collections).

You may be surprised to find that your credit reports do not include your
credit score. The reason for this is quite simple: The 2003 law mandating that
the three credit agencies provide a free credit report annually to each U.S. citizen
who requests a copy did not mandate that they provide the credit score.

Thus, if you wish to obtain your credit score, it’s going to cost you.
You can request your credit score from Fair Isaac, but you’ll get whacked $15
for every request (that can set you back $45 to see your FICO score for each
credit bureau). Save your money. If you’re going to purchase your credit
score, you can do so for less from the individual credit bureaus — Equifax,
for example, charges just $7.

If you do spring for your current credit score, be clear about what you’re
buying. You may not realize that you’re agreeing to some sort of an ongoing
credit monitoring service for say $50 to $100 per year.

How To Determine Your Financial Net Worth

Your financial net worth is an important barometer of your monetary health.
Your net worth indicates your capacity to accomplish major financial goals,
such as buying a home, retiring, and withstanding unexpected expenses or
loss of income.

Your financial net worth has absolutely, positively no relationship to your
worth as a human being. This is not a test. You don’t have to compare your
number with your neighbor’s. Financial net worth is not the scorecard of life.

Your net worth is your financial assets minus your financial liabilities:

Financial Assets – Financial Liabilities = Net Worth

The following sections tell you how to determine those numbers.

Calculation of financial assets:

A financial asset is real money or an investment you can convert to hard dollars
that you can use to buy things now or in the future.

Financial assets generally include the money you have in bank accounts,
stocks, bonds, and mutual fund accounts.

Money that you have in retirement accounts (including those
with your employer) and the value of any businesses or real estate that you
own are also included.

I generally recommend that you exclude your personal residence when figuring
your financial assets. Include your home only if you expect to someday
sell it or otherwise live off the money you now have tied up in it (perhaps by
taking out a reverse mortgage). If you plan on someday tapping into the equity
(the difference between the market value and any debt owed on the property),
add that portion of the equity that you expect to use to your list of assets.

Assets can also include your future expected Social Security benefits and
pension payments (if your employer has such a plan). These assets are usually
quoted in dollars per month rather than in a lump sum value. I explain in
a moment how to account for these monthly benefits when tallying your
financial assets.

Consumer items — such as your car, clothing, stereo, and wine collection —
do not count as financial assets. I know that adding these things to your
assets makes your assets look larger (and some financial software packages
and publications encourage you to list these items as assets), but you can’t
live off them unless you sell them.

Calculation of financial liabilities:

To arrive at your financial net worth, you must subtract your financial liabilities
from your assets. Liabilities include loans and debts outstanding, such as
credit card and auto loan debts. When figuring your liabilities, include money
you borrowed from family and friends — unless you’re not gonna pay it back!
Include mortgage debt on your home as a liability only if you include the
value of your home in your asset list. Be sure to also include debt owed on
other real estate — no matter what (because you counted the value of investment
real estate as an asset).

The table below provides a place for you to figure your financial assets. Go ahead
and write in the spaces provided, unless you plan to lend this book to someone
and you don’t want to put your money situation on display.

Your Financial Assets
Account                                                                        Value
Savings and investment accounts
(including retirement accounts):
Example: Bank savings account                                     $5,000
________________________________                           $_________
________________________________                           $_________
________________________________                           $_________
________________________________                           $_________
________________________________                           $_________
________________________________                           $_________
                                                                           
                                                    Total =                     $_________

Benefits earned that pay a monthly retirement income:
                           
                               Employer’s pensions                       $_________ / month
                              Social Security                                $_________ / month
                                                                                      × 240*
                                                                  Total =       $_________
        Total Financial Assets (add the two totals) =          $_________
 -----------------------------------------------------------------------------------------------------------------
* To convert benefits that will be paid to you monthly into a total dollar amount, and for purposes of simplification, assume that you will spend 20 years in retirement. (Ah, think of two decades of lollygagging around — vacationing, harassing the kids, spoiling the grandkids, starting another career, or maybe just living off the fat of the land.) As a shortcut, multiply the benefits that you’ll collect monthly in retirement by 240 (12 months per year times 20 years). Inflation may reduce the value of your employer’s pension if it doesn’t contain a cost-of-living increase each year in the same way that Social Security does.
------------------------------------------------------------------------------------------------------------------

Now comes the potentially depressing part — figuring out your debts and loans

Your Financial Liabilities
Loan                                                                          Balance
Example: Gouge ’Em Bank Credit Card                        $4,000
________________________________                         $_________
________________________________                         $_________
________________________________                         $_________
________________________________                         $_________
________________________________                         $_________
________________________________                         $_________

                    Total Financial Liabilities =                     $_________


Now you can subtract your liabilities from your assets to figure your net worth in Table below

Your Net Worth
Find                                                                               Write It Here
Total Financial Assets                                                     $_________
Total Financial Liabilities                                              – $_________

                                             Net Worth =                      $_________


What to know from net worth results:

Your net worth is important and useful only to you and your unique situation
and goals. What seems like a lot of money to a person with a simple lifestyle
may seem like a pittance to a person with high expectations and a desire for
an opulent lifestyle.

If your net worth (excluding expected monthly retirement benefits such as those
from Social Security and pensions) is negative or less than half your annual
income, take notice. You have lots of company — in fact, you’re with the
majority of Americans. If you’re in your 20s and you’re just starting to work,
a low net worth is less concerning.

Getting rid of your debts — the highest-interest ones first — is the most
important thing. Then you need to build a safety reserve equal to three to six
months of living expenses. You should definitely find out more about getting
out of debt, reducing your spending, and developing tax-wise ways to save
and invest your future earnings.

How to Avoid Common Money Mistakes

Financial problems, like many medical problems, are best detected early
(clean living doesn’t hurt, either). Here are some common personal financial
problems I’ve seen in my work as a financial counselor:

Not planning: Human beings were born to procrastinate. That’s why we
have deadlines (like April 15) — and deadline extensions (need another
six months to get that tax return done?). Unfortunately, you may have no

explicit deadlines with your overall finances. You can allow your credit
card debt to accumulate, or you can leave your savings sitting in lousy
investments for years. You can pay higher taxes, leave gaps in your
retirement and insurance coverage, and overpay for financial products.
Of course, planning your finances isn’t as much fun as planning a vacation,
but doing the former can help you take more of the latter. 

Overspending: Simple arithmetic helps you determine that savings is the
difference between what you earn and what you spend (assuming that
you’re not spending more than you’re earning!). To increase your savings,
you either have to work more (yuck!), increase your earning power
through education or job advancement, get to know a wealthy family who
wants to leave its fortune to you, or spend less. For most of us, especially
over the short-term, the thrifty approach is the key to building savings
and wealth. 

Buying with consumer credit: Even with the benefit of today’s lower 

interest rates, carrying a balance  month-to-month on your credit card 

or buying a car on credit means that even more of your future earnings 

are going to be earmarked for debt repayment. Buying on credit encourages 

you to spend more than you can really afford. 

Delaying saving for retirement: Most people say that they want to retire

 by their mid-60s or sooner. But in order to accomplish this goal, most 

people need to save a reasonable chunk (around 10 percent) of their incomes 

starting sooner rather than later. The longer you wait to start saving for 

retirement, the harder reaching your goal will be. And
you’ll pay much more in taxes to boot if you don’t take advantage of the
tax benefits of investing through particular retirement accounts. 

Falling prey to financial sales pitches: Great deals that can’t wait for a little

reflection or a second opinion are often disasters waiting to happen. A sucker 

may be born every minute, but a slick salesperson is
pitching something every second! Steer clear of people who pressure
you to make decisions, promise you high investment returns, and lack
the proper training and experience to help you. 

Not doing your homework: To get the best deal, shop around, read reviews, 

and get advice from objective third parties. You also need to
check references and track records so that you don’t hire incompetent,
self-serving, or fraudulent financial advisers. But with all the different 

financial products available, making informed financial decisions has become an
overwhelming task. I do a lot of the homework for you with the recommendations
in this book. I also explain what additional research you
need to do and how to do it.

Making decisions based on emotion: You’re most vulnerable to making
the wrong moves financially after a major life change (a job loss or
divorce, for example) or when you feel pressure. Maybe your investments
plunged in value. Or perhaps a recent divorce has you fearing that
you won’t be able to afford to retire when you planned, so you pour
thousands of dollars into some newfangled financial product. Take your
time and keep your emotions out of the picture. 

Not separating the wheat from the chaff: In any field in which you’re
not an expert, you run the danger of following the advice of someone
who you think is an expert but really isn’t. This book shows you how to
separate the financial fluff from the financial facts.  You are the
person who is best able to manage your personal finances. Educate and
trust yourself!

Exposing yourself to catastrophic risk: You’re vulnerable if you and your
family don’t have insurance to pay for financially devastating losses.
People without a savings reserve and support network can end up homeless.
Many people lack sufficient insurance coverage to replace their
income. Don’t wait for a tragedy to strike to find out whether you have
the right insurance coverage. 

Focusing too much on money: Placing too much emphasis on making
and saving money can warp your perspective on what’s important in life.
Money is not the first or even second priority in happy people’s lives.
Your health, relationships with family and friends, career satisfaction,
and fulfilling interests should be more important.