Tuesday, October 21, 2014
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Tough Times Series: Credit Savvy Is Key to Avoiding Costly Missteps



There's a lot of misinformation floating around about how to shop for, use, and benefit from credit. Consumers who are able to separate fact from fiction can avoid costly mistakes. Here, we reveal the truth behind 12 of the most common credit myths.

1. Myth: There's no reason to check my credit reports if I always pay my bills on time.

Reality: A 2004 report from U.S. Public Interest Research Group (USPIRG), "Mistakes Do Happen: A Look at Credit Report Errors," revealed "serious errors ... such as false delinquencies or accounts that did not belong to the consumer" in one-quarter of the credit reports surveyed. Because mistakes still happen frequently, it's up to you to make sure your credit report from each of the three major credit reporting bureaus (Equifax, Experian, and TransUnion) accurately reflects your payment history.

You are entitled to a free credit report from each credit bureau once every 12 months. To order, visit AnnualCreditReport.com. It's a good idea to check all three reports each year because an error in one won't necessarily show up in another. Follow the instructions included with the reports if you have to dispute an item.

Checking your credit report is also a good way to find out if you are a victim of identity theft. Look for accounts you don't recognize and balances on credit cards you haven't used. If you find anything suspicious, follow the instructions on the Web sites of the Federal Trade Commission, the Privacy Rights Clearinghouse, and the Identity Theft Resource Center.

2. Myth: If I have bad credit, I can pay someone to repair it for me.

Reality: There's no quick fix for a low credit score, though there are plenty of scammers who will try to convince you otherwise.

"Anything they say they can do for money up front, you can do for free," says Rick Harper, vice president of program services for Consumer Credit Counseling Service of San Francisco.

In the past, credit repair schemes centered on having unfavorable, but accurate, items removed from a credit report by disputing them. This was often successful because bureaus were required to flag an account within five days of receiving a dispute letter. The information in dispute would not count in the credit score while it was being investigated, and that would increase the score—temporarily. An update to the Fair Credit Reporting Act in 1997 gave bureaus the right to ignore disputes that seem frivolous. In other words, if you dispute everything, you get nowhere.

There's no quick fix for a low credit score.

A new tactic that has become popular on the Internet invites consumers with lower credit scores to pay a fee to be added as an authorized user on accounts that belong to someone with excellent credit. In response, Fair Isaac Corporation, the company that developed the widely used FICO credit scoring formula, decided that as of Sept. 1, 2007, an authorized user's FICO score would not reflect the payment behavior of the main accountholder.

Generally speaking, derogatory information, such as late payments and accounts sent to collections, remains on your credit report for up to seven years. A bankruptcy filing appears for seven to 10 years. Favorable information can appear indefinitely.

The best way to improve your credit score is to pay your bills on time and keep your balances low relative to your available credit.

3. Myth: The higher my income and assets, the better my credit score will be.

Reality: The consumer education site run by Fair Isaac, myFico.com, explains what goes into your score and what doesn't.

Your FICO score is based on your payment history, amounts owed, length of credit history, new credit (this includes recent inquiries and new accounts opened), and the types of credit used.

The score does not take into account your salary or assets, occupation, title, employer or employment history, or age. However, lenders may consider this information when deciding whether or not to grant you credit. And it may be included in other, non-FICO scoring calculations.

Race, color, religion, national origin, sex, and marital status also are excluded.

Your score most likely will be somewhat different at each of the three bureaus; they do not share data with each other.

Download "Understanding Your FICO Score" to learn more.

The VantageScore is another scoring system that the three major credit bureaus have developed. It's based more on an academic grading scale.

4. Myth: Shopping around for a loan will hurt my credit score.

Your credit score does not take into account your salary or assets, occupation, title, employer or employment history, or age.

Reality: It's true that a lot of voluntary lender inquiries (those that you initiate) within the past year can make it look like you're taking on a lot of new debt, or that you are shopping for new credit but are being repeatedly rejected. This can hurt your credit score.

In most cases, though, credit scores are not adversely affected by "rate shopping"—multiple inquiries from mortgage or auto lenders within a relatively short period of time (around 14 to 45 days, depending on which version of the credit scoring formula is being used).

Find out more in the "Learn" section of the myFico.com site.

5. Myth: I should close old, unused credit accounts to improve my credit score.

Reality: It may seem illogical, but closing old accounts actually might hurt your score.

While it's generally a good idea to limit your open accounts and available credit, there is a benefit to keeping older, low- or zero-balance accounts open. That's because the scoring formula rewards consumers for having a longer, well-established credit history. Closing older accounts makes your credit history shorter.

Also, closing an account with little or no balance makes your potential debt greater in proportion to your available credit, and that typically lowers your score. You want to keep your "utilization rate"—the percentage of credit that's available to you that you're using—low.

6. Myth: When I get married, our credit scores will be merged.

Reality: Every credit report, and credit score, is tied to a single Social Security number. No third, combined credit report is created, even after marriage. However, joint accounts—credit you apply for together—will appear on both reports.

Be aware that if you divorce, you are not off the hook for joint debts, even if the divorce settlement assigns the debt to your "ex." Creditors will continue to report account activity on both reports, and will look to both of you for payment, if necessary. If your partner doesn't make the payments, even if he or she promised to, your credit will be damaged unless you step in and cover what's due. When a breakup seems inevitable or imminent, try to convert joint accounts into individual names.

Closing old credit accounts actually can hurt your score.

7. Myth: It's smart to take out a home equity loan to pay off high-interest credit card debt.

Reality: "There's a lot of danger in this myth," says Harper, whose credit counseling agency educates thousands of consumers each year on how to use credit wisely.

While home equity can be a low-cost, tax-deductible way to finance items like a car or tuition, Harper says, it takes a very disciplined borrower to avoid trouble. Borrowers who continue to "go back to that well" and never change their spending habits eventually will tap out their home's equity and have no place to turn for more money. And if you're one of the many home buyers whose property has lost value recently, you may not be able to sell your home for a price that will cover your loans.

Harper says there's also an inherent risk in taking unsecured debt--credit cards, for example-- which could be discharged in bankruptcy, and converting it into debt secured by your home. If, say, due to job loss or medical emergency, you were not able to make the payments on your home equity loan, you could face foreclosure.

Another consideration is the sheer expense of amortizing what should be short-term debt into long-term obligations. Do you really want to pay off your vacation for the next 20 years?

If you're considering a home equity loan because you're already juggling too much debt, explore all your options with a credit counselor. Find an accredited, nonprofit agency through the National Foundation for Credit Counseling.

8. Myth: Credit counseling will hurt my credit score and keep me from getting a mortgage.

Reality: According to myFICO.com, merely participating in a credit counseling agency's debt management plan (DMP) will have no effect on your score. Your credit score could be harmed, however, if you're participating in a DMP and one or more of your creditors reports your payments as late, as many do. In many cases, these creditors will "re-age" your account—report it as current—after you complete the repayment program. In the meantime, though, those late payments will lower your FICO score.

Just to be safe, Harper, whose agency is certified by HUD to provide housing counseling, advises anyone already in escrow or close to it not to jeopardize their financing by starting a debt-management plan until escrow closes.

The rate on your fixed-rate credit card is not necessarily permanent.

On the other hand, he says, excessive debt is one of the biggest obstacles to home ownership. If you're already in trouble, credit counseling and a DMP can help you get back on track, increase your credit score, and improve your chances of qualifying for a mortgage.

9. Myth: The interest rate on my fixed-rate credit card can't be raised.

Reality: Unlike a fixed-rate mortgage, whose rate can't be changed for the life of the loan, a fixed-rate credit card carries no such guarantee. To impose any "material" change of terms—which, in addition to a rate increase, would include such things as a late fee increase, a currency conversion fee increase, or conversion from a fixed rate to a variable rate—the card issuer must simply provide 15 days' written notice. These change-of-term notices usually come with your monthly billing statement, so read all bill stuffers carefully before discarding them.

That's especially important to know if you're carrying a huge balance and would experience a significant increase in the monthly payment with a higher rate, says Linda Sherry, a chief spokesperson for San Francisco-based nonprofit Consumer Action.

Sherry says consumers don't have a lot of options when their interest rate increases. You can, of course, accept the rate change and go on using your card as usual. Or you can reject the rate change, which essentially means you'll need to close the card and pay your entire existing balance. You can ask the financial institution if you can pay off your balance over time at the old rate—they are not required to let you, but some card issuers do. You could also transfer the balance to another card with a better rate if you can get one.

Sherry also reminds cardholders that issuers are not required to notify you of a "penalty" rate increase, which kicks in if you miss one or two payments, or a "universal default" increase, which could raise your rate if you're late paying other bills.

The Consumer Action 2007 Credit Card Survey makes it easy to compare credit card rates and terms. Credit unions fared especially well in a Consumer Reports study about credit card rates, fees, and customer satisfaction. If you don't already have a credit union credit card, investigate one.

The most important action car buyers can take is to call their credit union for an auto loan rate quote before talking about financing with a dealer.

10. Myth: I can only build a good credit history if I carry a balance.

Reality: There's no need to pay finance charges to build good credit. You just need to have credit available to you, use it, and pay it back according to the terms of the agreement. In other words, make at least the minimum monthly payments on time, or pay off the whole balance by the due date. And remember—your grace period only applies if you carry no balance from month to month—another incentive to pay credit card bills in full whenever you're able to.

11. Myth: A car dealership must pull my credit report before I can take a test drive.

Reality: The dealership certainly has a right to make sure you're a licensed driver. However, it doesn't have the right to pull your credit report without your permission or a legitimate business reason to do so, which often is what happens without your knowledge.

Car dealers can make a lot of money in lining up your financing. Knowing your credit history, including your outstanding debt and the amount of your current or recent car payment, gives the dealer an advantage in negotiating your loan rate and terms.

In a 2006 press release, Stephen Brobeck, executive director of the Consumer Federation of America, Washington D.C., said the "most important action car buyers can take is to call their bank or credit union for an auto loan rate quote before talking about financing with a dealer."

If you decide to buy the car and still want to hear what kind of financing the dealership can offer, then you can authorize the dealer to pull your report. But don't take his or her word for it that your credit isn't good enough to get the best financing: Make sure you know your credit score before setting foot on the car lot. (See Myth No. 1 for information about obtaining your credit report.)

12. Myth: Co-signing a loan won't affect my credit score.

Reality: Any activity, good or bad, on a loan you co-sign will have an impact on your credit. If the person you co-signed for continues to pay the loan as expected, then your credit score will benefit. If he or she defaults (fails to make payments as promised), then the debt becomes entirely your responsibility. If you don't pay it, your credit score will reflect the default.

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