What You Can Do To Protect Your Identity

Despite our best efforts, our private information is housed with hundreds if not thousands of private companies and government agencies. We’re also personally barraged with direct attempts at our private data through phishing emails, IRS scam phone calls, and hacking public Wi-FI. These days thieves are more likely to want your Wi-Fi password than your wallet. According to a recent study, $16 billion was stolen from 15.4 million U.S. consumers in 2016. In the past six years, identity thieves have stolen over $107 billion.
This week, a massive security breach was announced at Equifax, one of the three major credit bureaus. The impact was estimated at about 143 Million people or basically half of the country in one of the largest cyber security breaches ever. Whether or not you have chosen to do business with this firm, they likely have a great deal of your personal information including your address, birth date, social security number, driver’s license info, credit card numbers, and financial records.
Equifax has set up a program to help people protect themselves and their data from potential identity theft, but it’s not without its challenges:

  1. The online tool Equifax set up to notify people whether or not they have been impacted has been beset with errors. Many people have received conflicting information about whether they were impacted after putting in the same information multiple times. It’s best to assume you have been impacted whether the tool says so or not. The tool requires 6 digits of your social security and your last name to find this information out, which is highly irregular and doesn’t inspire confidence from the firm that just got hacked.
  2. Equifax offers a complimentary credit monitoring protection program but gives you a date (which can be a week away) for when you can enroll. Your private information has been stolen since May, but give us one more week before we can help you.
  3. The identity protection program is by TrustedID, Equifax’s own program which offers credit monitoring for a year.
    This is kind of like a restaurant that had an E. Coli outbreak offering you a free meal coupon afterward.
    To enroll in TrustedID, it requires additional personal information and your credit card, which may auto charge you once the trial ends next year. Surprise! It feels like a bit of self-dealing and an attempt to profit from their own crisis.
  4. In the terms of conditions of the TrustedID program, there is a forced arbitration clause which potentially limits your rights to be part of any class action lawsuit going forward. After intense backlash, Equifax recently commented that clause won’t apply to this breach, but yet they did not waive the clause.
  5. Top executives at Equifax sold hundreds of thousands of dollars of stock after the breach was known internally but before making it public. This could be a complete coincidence but again looks like self-dealing.

Those are some serious challenges which don’t inspire a great deal of confidence. So let’s talk about what you can do to protect yourself now and in the future.

1. Check Your Credit Report

Regardless of whether you decide not to enroll in the TrustedID program, you should check your credit reports. You can access your credit reports for free at annualcreditreport.com. You can get one free report from each of the three main bureaus (Equifax, TransUnion, Experian) annually, so most people spread them out quarterly. You want to look for any accounts you don’t recognize. If you see accounts you don’t recognize, contact the company and speak to their fraud department immediately. The Federal Trade Commission also has additional information and resources.


2. Set Fraud Alerts or Freeze Your Credit

Freezing your credit will stop anyone (including yourself) from opening any credit accounts in your name until the account freeze is lifted. In order to lift the freeze, you will have to call the bureaus and provide the PIN that was given at the time the credit freeze was issued. This is the strongest protection measure, but not recommended if you are planning to open new credit in the near future (purchase a car, home, etc). There is a charge to enact the freeze (typically $5-$10 per person for each bureau) and a charge to temporarily or permanently lift the freeze (varies by state).
A fraud alert, on the other hand, is free and basically like two-factor authentication for your credit. The credit issuing company will have to verify your identity before opening an account. Fraud alerts last for 90 days but can be renewed. You can set fraud alerts by calling or going online at the three major bureaus.

3. Consider purchasing ID Theft Insurance

Identity theft is broader than someone accessing your credit card number and purchasing stuff. It can also mean using your social security number to access loans, medical services, government benefits, and tax refunds. With most crimes, if you are a victim, you call the police and outsource capturing and punishing the criminal. When your identity is stolen, you are both the victim and a potential perpetrator, so you’re guilty until proven innocent. You have to prove you are who you say you are and that you are the victim. That’s a different ball game altogether.
ID Theft Insurance doesn’t pay for the money stolen from you or in your name, but it reimburses you for the expenses involved in recovering your identity, such as legal fees. More importantly, if there is an identity theft incident, having a contact to help you resolve the issue quickly and efficiently is key. I’ve personally purchased ID Theft Insurance for the past 10 years from Zander Insurance at the recommendation of Dave Ramsey, and with each new data breach I see, I’m grateful for it. They’ve offered a fantastic inexpensive service which not only monitors your credit, but can also monitor your social security number, change of address, and other personal information (i.e. driver’s license, medical insurance, credit/debit card) should you choose.

4. Check Your Accounts Consistently

You cannot completely prevent ID theft, but you can limit the damage by checking your financial accounts consistently. Free services like Mint.com can aggregate your financial accounts and you can check daily for new transactions. You can also set alerts to receive notifications for purchases over a certain amount. Also, services like Credit Karma or Credit Sesame will allow you to check your credit more frequently. Keep in mind these free services only access one or two credit bureaus.  

5. File Your Taxes Early

Imagine going to file your taxes and expecting a refund to receive a message that your taxes have already been filed. The IRS has a huge issue with tax fraud through identity theft. Identity thieves are using stolen social security numbers to steal millions of dollars of tax refunds from unsuspecting individuals. Filing early is a way to defend against that possibility. The IRS has additional information on safeguards for ID theft

The #1 Killer of Wealth in America

It’s not a surprise to hear stories these days about the middle-class shrinking. A big part of that trend has to do with the lack of sustained wage growth for decades. Families were essentially standing still financially while the tide of inflation continued to rise. The tide came in and many families are underwater. However, stagnant wages and inflation are not the full story and may not even be the most important part.
During this time of relatively flat wage growth, one would think that personal spending would go down. Typically people spend less when prices go up. For example, when gas prices go up, people tend to drive less. However, over the years, the complete opposite happened, while wage growth has been flat for the past 30 years, consumer spending has shot through the roof!
How do you explain that? One word. Credit.

Misuse of Credit Kills Wealth

We’re not looking to bore you with the history of credit, but as consumers, the only way to spend what you don’t have is to borrow. Over the past 40 years, banks have made credit such a regular part of everyday life, that today, you likely may not know an adult that doesn’t own at least 1 credit card. Imagine before credit cards, where you had to walk into a bank and fill out all kinds of paperwork to get a personal loan. We must acknowledge, access to credit is actually a good thing when used properly. The problem comes when credit is misused or financial products are designed in such a lopsided fashion that debt problems are inevitable.
The way most people build wealth is to consistently save over an extended period of time. They use those savings to invest in the stock market, real estate, or to build/invest in businesses. Unfortunately, as credit availability grew and became mainstream, personal saving rates did the exact opposite.
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Above is a chart showing the outstanding credit since 1970. Keep note that credit cards really didn’t start becoming mainstream until the 80’s. You’ll notice that credit begins to skyrocket in the 80’s and hasn’t stopped since. Compare that to the chart below showing personal savings rates. People used to regularly save 12-15% of their income in the 70’s, but now it’s down to 5%. One guess on where that 10% difference went. According to a NerdWallet study in 2016, the average family with credit card debt pays $1,292 in credit card interest per year. That does not include interest paid on student loans, auto loans and mortgages.
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This is not all about reckless consumer spending, there’s plenty of blame to go around. Inflation, lack of government regulation and complex, misleading terrible financial products are a large part of the problem. For example, recently auto dealers started extending 8-year auto loans. Depending on the interest rate, a borrower could pay as much in interest on that loan as the car itself. Imagine paying $50K for a $25K car and at the end of those 8 years, the car is worth less than $5K. The point is paying interest to banks is the exact opposite of building wealth. The money spent on interest payments for credit cards, auto loans, student loans, mortgages is money not saved and not invested.
It’s not about whether credit/debt is good or bad. Consumers need to be much more savvy about the cost of borrowing money. It’s not simply the monthly payment, but the amount of interest over time and what one is losing out on by paying that interest. It’s about making an active decision about which side of compound interest you want to live on. You’re either paying interest and growing the profit of banks or receiving interest by investing and growing your own wealth. Choose wisely.

What You Need to Know About Credit Scores: Part 2

Credit scores are an important piece of your overall financial puzzle. In Part 1, we demystified credit scores by discussing what they are, who uses them and where to find them. Now we’ll describe the best ways to improve your credit score.
In order to improve your score, you need to understand the rules of the game, so you can play it effectively. First, let’s review the five elements of a credit score and then we’ll discuss the best ways to improve your score.

  1. Payment History (35% of the total score) – This element measures whether you have paid your past accounts on time (e.g credit cards, retail store cards, car loans, mortgage loans, student loans)
  2. Amounts Owed/Credit Utilization (30% of the total score) – This element measures the total amount of debt owed on all of your accounts. It looks at different types of debt like installment accounts with a fixed payment schedule (e.g. car, mortgage) as well as revolving accounts (i.e. credit cards).
  3. Length of Credit History (15% of the total score) – This element measures the time since your credit accounts have been established. The longer the credit history, the better. It will consider an average length of your credit accounts.
  4. New Credit (10% of the total score) – This element measures the number of recent credit inquiries in the prior 12 months.
  5. Credit Mix (10% of the total score) – This element simply measures the different types of credit accounts you have.

Note that the first two elements represent nearly two-thirds of your overall credit score. This is where you get the biggest bang for your buck. So let’s get right to it. Here are five tips to improve your credit score.

  1. Review Your Credit Report and Dispute Errors

This may be obvious, but you don’t want to be held responsible for transactions that aren’t yours. Reporting errors happen with regularity, so you should check your credit reports from all three bureaus every few months. By law, you are allowed one report per year from each of the three credit bureaus from annualcreditreport.com, so you can stagger them and check one every four months.
If you see an error (e.g. accounts that don’t belong to you, paid off collection accounts showing as unpaid, incorrect name or address listed) you are able to dispute it online and it is the obligation of the creditor to prove to the bureau that the report is valid 30-45 days from receipt.
 

  1. Pay Bills on Time (Payment History)

    Late payments can significantly impact your credit score, particularly if you do not have much credit history. Even if you can only make the minimum payment, always try to stay current. This includes bills like rent, utilities, medical bills and student loans. If you can’t make the minimum payment, notify your creditor beforehand and see if you can work out a payment plan. Communication in advance is preferable to simply not paying and ignoring them. Creditors will typically report late payments to credit bureaus for balances that are 30+ days past due (180+ days for medical bills).
    Bonus Tip: Recent late payments affect your score more that older late payments, so if you have multiple accounts that you’re behind on, consider getting current on the more recent one first. Also, note that you have a longer window (180 days vs. 30 days) with medical bills before they are reported to get current.

 

  1. Keep Balances Low on Revolving Debt (Amounts Owed)

    A credit utilization ratio (Amount Owed/Credit Available) above 30% will begin to negatively affect your score. Even if you’re paying minimum payments, if your credit cards are maxed out, your credit score will be impacted. Also, trying to reduce your credit card balances while still using the credit card is a losing game. Stop using the card if you are trying to significantly reduce your balance.
    Bonus Tip #1: If your credit card is in good standing and you’ve made on time payments for 12 consecutive months, contact the creditor to see if they will increase your credit limit without a hard pull credit inquiry. If they are willing to increase your limit, you can improve your utilization ratio with little effort.
    Bonus Tip #2: If you have a spouse or close family member you trust who has a credit card in good standing, they can add you as an authorized user on their credit card. They don’t have to give you the card (it’s preferable if they didn’t), but they are simply extending their credit to you, which increases Credit Available and decreases the Utilization Ratio.
    Caution: Being an authorized user goes both ways, so any negative behavior (late payments, collections, etc.) on that account (by either party) can negatively impact your credit just like your individual account.

 

  1. Don’t Close Old Credit Card Accounts (Length of Credit History)

You may have heard advice in the past that if you have old credit cards on your credit report, you should call them and close them out to keep your credit report “clean.” That’s likely bad advice for two reasons. First, even if you don’t use the card, the credit limit adds to your Available Credit and helps your Credit Utilization. Second, the Length of Credit History takes an average of all of your open accounts. The more old accounts you have the longer that average will be. Closing the account simply eliminates the history from benefitting your score.
Bonus Tip:  You can request creditors remove negative incidents from your report. For example, if you had a late payment a year ago or more and you’ve been current, you can contact the creditor and request they remove that incident. They are not obligated to (until after 7 years), but they may oblige as a courtesy for customer satisfaction and to keep your business.
 

  1. Don’t Apply for New Credit Cards Solely to Increase your Available Credit (New Credit)

    Even though New Credit is only 10% of your score, credit inquiries (also called hard credit pulls) stay on your credit for a full year. So applying for a new credit card solely to increase your available credit is counterproductive. You get dinged for the hard credit pull and you’ve reduced the average length of your credit history. If you’re looking more long-term and not concerned about the short-term impact on your score, this is less of a concern.
    Bonus Tip: Checking your own credit is not considered a hard pull credit inquiry (it’s called a soft pull inquiry). Soft pulls are typically for background checks, opening utility accounts, and open a checking or savings accounts. Soft pull inquiries will not affect your credit score.

 
Those are some of the best ways to improve your credit score. Remember to be patient as scores don’t shift dramatically overnight and account changes often lagged by 30 days or more. If you’re looking to make dramatic changes to your score (100+ points) it may take 6 months or more depending on your situation. Credit scores are much easier to pull down than to bring up, so it’s important that you stay diligent. Finally, remember your credit score is just a number, a debt management score. It doesn’t measure your overall financial health and it is a point-in-time metric that can be improved.

What You Need to Know About Credit Scores: Part 1

Credit scores are an important aspect of your financial life and unfortunately, there is quite a bit of confusion about what credit scores are, how they work and who uses them. There’s also a ton of shaming involved with credit that is unjustified. In this two-part series, we will clear up some confusion about credit scores and help you improve your scores.
 

What is a Credit Score?

A credit score is a three-digit number (typically from 300-850) calculated to assess an individual’s credit-worthiness. Said another way, a credit score is based on multiple factors which allow a lender to determine how risky it may be to lend to an individual. The lower the credit score, the riskier (theoretically) to lend.
Remember when you were a kid and you lent your friend a few dollars for lunch or you let them borrow one of your video games. You may actually still remember some of your “ex-friends” that didn’t pay you back or return your possessions! What if you had a way to determine the likelihood of your friend paying you back or returning your item in advance based on their history of borrowing from others in the past? THAT’S the goal of credit scores and while it is flawed, it is important to understand how you are being measured.
There are many companies involved in the business of measuring credit-worthiness. The most widely known and used score in the U.S. is called a FICO Score and there are three major credit bureaus which the majority of lenders access to obtain individual FICO credit scores. TransUnion, Equifax, and Experian are the three major credit bureaus that hold your credit data and calculate your credit score.

Why is a Credit Score Important?

Clearly, credit scores are important for financial lenders because it helps them make decisions on whether or not to lend money and how much to charge. However, even if you are debt free and don’t borrow money, your credit score can still impact you. Increasingly more companies are using credit scores to make decisions including landlords for renting apartments, home and auto insurance companies, and utilities such as cell phone and cable companies.
The ranges on the credit score allow lenders charge you more (i.e. higher interest rates) for the same products. Of course, these ranges can vary by lender, but here’s an example:

  • 720 – 850: Excellent ‘A’ Credit – This score range typically qualifies the best rates on mortgages, credit cards, and car loans.
  • 680 – 719: Good ‘B’ Credit – This score range will qualify for different types of credit, but may not always get the advertised or premium rates
  • 630 – 679: Fair ‘C’ Credit – This score range may or may not qualify for different types of credit and will have higher interest rates.
  • Under 629: Poor ‘F’ Credit – This score range will typically not qualify for different types of credit and may require a cosigner or collateral (i.e. a secured deposit). This is also referred to as ‘subprime’ credit.

For a benchmark, the average credit score in the U.S. is about 690. What is important to understand is not to personalize or internalize your credit score. You are not wonderful and successful if you have an 800 score and you are not a failure if you have a sub 600 score. It is simply a point-in-time metric of your past interactions with credit and fortunately, you have some level of control to significantly impact that score over time which we will discuss in Part 2.

What Credit Scores Do NOT Consider

As mentioned, credit scores are flawed. They can be based on inaccurate or even fraudulent data and there are also important factors that are not taken into consideration. Credit reports (different from credit scores) list the details of financial accounts upon which the credit score is based. Personally, I have found errors on my credit report simply because I share a name with my father. In a separate instance, my father discovered identity theft when checking his credit report and found a $20,000 loan for dentistry school taken out in his name that he had no connection to. These errors are YOUR responsibility to correct which is why you should check your credit score and credit reports regularly.
Credit scores neither take income nor savings into account and credit scores are not a complete measure of how well you are doing financially. Many refer to the credit score as a ‘debt management score’ because it simply measures how well you borrowed money and paid it back. Net Worth is a much better measure of financial success. For example, two individuals (Person A & B) could have the same credit history and the same credit score even though person A makes $1 million in income per year and has $1 million in savings and Person B makes $30,000 per year and has $0 in savings. As a lender, I would likely prefer to lend to Person A, but the scores will show the exact same number. Keep in mind lenders can ask about income and savings before lending, but it is not a factor in your credit score. Also, for those coming out of high school or college that do not have a credit card and have not borrowed money in the past, they may not even have a credit score. So if you diligently manage your finances with cash and don’t rely on credit, you may find that you do not have a credit score.

What are the Elements of a Credit Score?

Let’s talk about what is actually included in the credit score and in Part 2 we’ll discuss tips on how to improve that score. There are five elements in the calculation of a credit score and they have different weights of importance.

  1. Payment History (35% of the total score) – This element measures whether you have paid your past accounts on time (e.g credit cards, retail store cards, car loans, mortgage loans, student loans)
  2. Amounts Owed/Credit Utilization (30% of the total score) – This element measures the total amount of debt owed on all of your accounts. It looks at different types of debt like installment accounts with a fixed payment schedule (e.g. car, mortgage) as well as revolving accounts (i.e. credit cards). For installment accounts, it looks at the remaining balance versus the total amount borrowed, so if you have a $10,000 balance on your car loan and you originally borrowed $20,000, it would show that you still owe 50% of the balance of the loan. For revolving accounts, a credit utilization ratio is used to determine the percentage of your overall credit limit is being used. For example, if you have three credit cards with a total credit limit of $10,000 and you owe a total of $2,000, your credit utilization ratio would be 20%.
  3. Length of Credit History (15% of the total score) – This element measures the time since your credit accounts have been established. The longer the credit history, the better. It will consider an average length of your credit accounts.
    Tip: This is why you should reconsider before closing or canceling your oldest credit card accounts, even if you no longer use them.
  4. New Credit (10% of the total score) – This element measures the number of recent credit inquiries in the prior 12 months. The idea is if you are signing up for several credit cards in a short span of time, it increases the risk to lenders. In other words, people who open up several accounts in a short span of time typically plan to use them and use them heavily.
  5. Credit Mix (10% of the total score) – This element simply measures the different types of credit accounts you have. This is biased toward having credit cards, but also includes installment loans like car loans or mortgages as well as retail card accounts.

Where Do I Find My Credit Score?

Finally, let’s talk about where to get both our credit scores and reports. For the official FICO scores and credit reports, you can purchase them from FICO for a one-time purchase of $60 or different monthly plans. A better option, in our view, is to use FREE sites like Mint, Credit Karma, or Credit Sesame that are not the ‘official’ FICO score but do a decent job getting a close approximation. You can use one or all three and it will not affect your credit score. They can also provide you with the details of your credit report which you can view and check for erroneous information.
So we have demystified the credit score, discussed why it’s important and the elements considered and not considered. Again, your credit score is not a measure of personal value or personal success much like a GPA is not a measure of intelligence, but rather the combination of course grades. Also much like a GPA, your credit score is much easier to bring down than it is to pull up, so we have to be diligent about our finances. The purpose isn’t to have an 850 score, but to monitor your score and know how you can improve it to save money if you borrow in the future.

Credit Cards – To Use or Not To Use

Credit cards have dramatically changed consumers’ saving and spending habits. It would not be an exaggeration to say that credit cards have impacted personal finance as much as cell phones have impacted personal communication. Whether you are pro or anti-credit card, the impact of credit cards is indisputable, but it is important to understand common myths, as well as the pros and cons of credit cards so they don’t derail your financial goals.
We won’t go through the history of credit cards, but as a financial product, it’s relatively young. Credit cards as we know them today are a little more than 50 years old. That means Gen Xer’s grew up with them as they became prominent, and Millennials have never known a world without them. Let’s use this as an opportunity to quickly debunk some myths about credit cards:

  1. I have to have a credit card as some places won’t accept a debit card or cash

    Credit cards are not a necessity! If we stop and think about that thought process, that’s basically saying that we cannot survive without borrowing from Visa, AMEX or MasterCard. Insanity. Despite popular belief, cash is still king and debit cards are accepted everywhere credit cards are. To be fair, there are some caveats on debit cards for places like hotels and rental car companies that may put a hold on your debit card for the full amount until the transaction is complete (though you shouldn’t be using a debit card if there are insufficient funds in your bank account).I have to have a credit card in order to build my credit

  2. I have to have a credit card in order to build my credit

    Credit cards are not the only way to develop your credit or to improve your credit score. A college student came in for a financial counseling session. She was considering getting a credit card before she graduated. She wanted to build her credit to get a car loan and an apartment in the future after she graduated and got a job. We pulled her credit report and it turns out she had an 800+ credit score. (Credit scores range from 300-850, the higher the better. Anything over 720 is considered to be excellent credit). Upon review of her credit report, it showed she had a credit card account in good standing since 2006. Now since she was born in 1995, I was pretty sure that she didn’t open a credit card when she was 11. I simply told her to call her parents, make sure it wasn’t a fraudulent account and then thank them for giving her the gift of great credit. Also, she shouldn’t even think about getting a credit card until she had a full-time job for at least one year.
    Her parents made her an authorized user on one of their credit cards as a child. They never told her, obviously didn’t give her a card, and most importantly they keep the card in good standing. As a 20-year-old college student, she had 9 years of positive credit history never having used a credit card before. Much like using your parents’ Netflix or cable password, you can (legally) piggyback on someone else’s credit by becoming an authorized user on their account. Make sure it’s someone you trust and the account remains in good standing (paid on-time and in full).
    Another way to build credit without a credit card is by paying installment loans (loans with a regular payment for a fixed period) such as car loans, student loans, mortgages. Paying the required payments on time will count towards your credit history and improve your credit score.
    Finally, fixing errors on your credit report is also a way to improve your credit without getting a credit card. Errors are prevalent in credit reports and you shouldn’t be punished because of an erroneous entry on your credit report. Review your reports from the three major credit bureaus quarterly to ensure accuracy.

  3. Carrying a credit card balance improves my credit score

    I’m not sure how this one got out into the ether, but having a credit balance in no way improves your score. Credit bureaus measure utilization rates meaning what percentage of your available credit are you using. Your credit score will begin to go down if you are using more than 30% of your available credit, but you are not penalized for paying off your cards in full each month.
    While we are at it, the number of cards you have is also not a factor. The average length of time you have a card is a factor, so you may see a slight decline after signing up for a new card, but the pure number of cards is not a factor.

So we’ve debunked some common credit card myths, let’s get into the pros and cons of credit cards:

Pros

  • Ease of transactions
  • Grace period to pay for charges
  • Easy to track spending
  • Protection for fraudulent transactions and ID Theft
  • Rewards points/Cash back/Airline Miles
  • Can be used to build credit score[/col-md-6][col-md-6]

Cons

  • Significantly reduces the ‘pain’ of transactions, increasing spending
  • Masks overspending with grace period
  • Charge cards are designed to pay interest
  • Interest rates are high (average 15%+)
  • Credit cards rewards incentivize additional spending not saving
  • Late payments and high utilization rates can significantly reduce your credit score

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It is not an exhaustive list, but we captured some key aspects of how credit cards can be positive and negative. Personally, we are not a fan of credit cards because they incentivize spending and reduce saving. A cash back reward or miles is an incentive to spend, whereas a 401k match, for example, is an incentive to save.

‘The more you spend, the more you save’ does not pass the smell test.
IN FACT IT SMELLS A LOT LIKE BULL.

 
Also, there is a real difference between pulling $50 cash out of your pocket and swiping a card. Pulling the $50 cash involves a bit of psychological pain. It forces you to observe how you are reducing the total amount of cash in your pocket instantaneously and may cause you to make a different decision. Have you ever been hungry and ate way too much? Well, it takes about 20 minutes for your brain to register that your stomach is full. That delay can cause us to overeat. When you use credit cards, that delay can be 30 days! You may not realize you overspent until the statement comes in a month later. Pain is actually a sensation that gives us an indication that there may be something wrong. Removing the pain of financial transactions is not all positive. Keep that in mind as we further reduce the pain by moving from credit cards to electronic payments such as PayPal, ApplePay, and Android Pay.
Our purpose is not to say credit cards are evil and should be banned entirely. However, the average US household had just under $16,000 in credit card debt in 2015. That means thousands of dollars in interest payments each year paid to MasterCard and VISA and not to savings or investments. Giving your hard-earned money to credit card companies is not the way to financial independence.
Personal finance is just that, it’s personal. You need to know what’s best for your own situation. In our opinion, the benefits of credit cards do not outweigh the costs. Spend less than you earn with cash and build an emergency fund, and if there is an emergency; borrow from yourself, not VISA.

Am I Financially Ready to Buy a Home? 6 Questions to Ask Yourself

Buying a home will likely be the most expensive purchase in your lifetime. You want to make sure you are prepared to be in the best position financially. There are some common misconceptions about renting that you may want to understand, but if you are emotionally ready to take on the home buying challenge, here are six questions to ask yourself to make sure you’re financially ready!

1. Do I have any consumer debt? (Student Loans, Personal Loans, Car Loans, Credit Cards)

Adding six-figure debt is a serious challenge and commitment. If you already have a significant amount of debt, you should consider focusing and eliminating these debts prior to incurring mortgage debt. A mortgage on top of consumer debt would increase your overall expenses and give you less financial flexibility. Paying lenders interest on debt is the opposite of building wealth.

2. Is my credit score above 720?

A credit score is simply a calculated score credit rating agencies produce that measures how well you manage debt; the higher the score the better. Lenders use this score to help determine their risk in lending to you. The higher the risk, the higher your interest rate which makes the borrowing cost of your home more expensive. There are several ways to reduce your cost of borrowing, but one is to ensure your FICO score is above a 720. FICO credit scores range from 300-850, but in most cases, a score at or above 720 is considered excellent credit and will get you the most preferred rates. Below 720 and you will pay additional interest because of credit risk. In future posts, we’ll discuss how to increase your credit score to minimize your borrowing costs.

3. Do I have a fully funded emergency fund? (minimum 6 months of expenses)

Having a fully funded emergency fund is essential even if you’re not purchasing a home, however, it becomes more important when you do purchase. You can no longer simply notify the landlord of a water leak, heat/AC issues, or a major appliance outage – it’s on you. Homeowner’s Insurance may cover some particular events, but even so, the insurance also has a deductible that you’ll have to cover out of pocket. We can’t predict emergencies, but we can financially prepare to deal with them knowing they will happen. Don’t allow these situations to send you into a financial tailspin of debt. Be prepared with at least 6 months of basic living expenses (e.g. housing, insurance, food, transportation, utilities) which is not part of your down payment.

4. Do I have 20% cash for a down payment? (Separate from an emergency fund)

A 20% down payment is important for multiple reasons. First, if you’re going to make potentially the most expensive purchase of your lifetime, it’s important that you have skin in the game. This means that you had sacrificed for a period of time to save above and beyond to make this happen and you’re fully invested. It also greatly reduces the probability of an impulse purchase.
Second, 20% of the purchase price as a down payment avoids Private Mortgage Insurance (PMI). PMI is an insurance policy the homebuyer pays on behalf of the lender in case the homebuyer defaults. PMI typically costs about 1% of the home purchase price annually and is added to the monthly mortgage payment. PMI can be canceled by the homebuyer once the homebuyer has 20% equity (Loan-to-value ratio of 80%). The bank is required to cancel PMI when the Loan-to-value ratio hits 78%. Depending on the size of the down payment, this could mean several years of additional fees. So, if that sounds like a rip off to you, then you’re starting to understand.

5. Am I planning to move within 7 years?

Mortgages are structured in a way that front loads interest payments. The lender gets much of their borrowing costs before you get your equity. In other words, the majority of the interest of the loan is paid earlier and the principal of the loan is paid down later. For example, depending on the interest rate, the first year of monthly payments could be 75% interest and 25% principal. That is important because, within the first seven years, you will likely not have much equity. Without equity, you will likely not able to achieve a return on investment (ROI), when you are ready to sell. If home prices fall during that time, you could find yourself under water (the balance owed on the mortgage is more than the current value of the home). If you move sooner than the equity in the home grows, you could end up still having to pay a monthly mortgage on a home that has already been sold.

6. Will my monthly housing costs (mortgage, insurance, taxes) exceed 30% of my monthly take-home income?

If you ask a real estate professional, such as a real estate agent or a mortgage broker, “How much house can I afford?” they will likely hear and answer a completely different question – more like ‘How much risk is my bank willing to take?’ or ‘How much commission can I make?’ That’s not a negative statement about real estate professionals, but they are financially incentivized to give you the largest mortgage they can get approved. It is your job to determine how much house you can afford. We recommend that your housing costs including the mortgage, insurance, and taxes not exceed 30% of your monthly take-home income. Can you afford more than 30%? Of course, but the goal of the financially savvy isn’t to get the largest mortgage possible. The goal is to purchase a home while having the flexibility to achieve other financial goals such as saving for child’s education, paying off the mortgage early and achieving financial independence. You want your home to be a financial benefit to your family, not a financial burden.
Purchasing a home is an important emotional and financial decision. On the emotional side, often people will make the mistake of comparing their first home purchase to their parents’ current home.  What you can comfortably afford 15-20 years from now may be drastically different from what you can afford today and that’s okay. On the financial side, to be financially prepared for a home purchase means not allowing the home to overtake other financial goals. Having the biggest house on the block is pretty meaningless if you can’t afford to furnish it, maintain it or take a vacation from it. Keep the bigger picture in mind!