Bad Credit? No Credit? All About Credit and FICO Scores

Mention credit scoring or FICO to most people, and you've got a conversation topic that's about as pleasant as income tax or root canals. "That's going to go onto your credit report" evokes much the same loathing from a modern consumer as "that's going on your permanent record" got from a schoolchild a couple decades or further back.

As recently as a couple years ago, credit scoring in general, and FICO scores in particular, were almost mystical entities that were all-but-inaccessible to the average consumer. Sure, you could pony up ten to twelve bucks and get your score, but there was no guide to interpreting the furlongs-per-fortnight number you got, and only cryptic hints as to why your score was the way it was. I remember rather vividly pulling my score a few years back, and under the explanation was indecipherable gobbledygook that even a lawyer would have had difficult wading through. I finally told the lady at the bank it would be much simpler for the computer to just print the words YOU SUCK! at the top of the page--that at least would have been clear.

Google wasn't even your friend then...you could enter in a credit scoring topic and get five different answers, some contradictory, none authoritative. It was enough to make someone with bad credit put their fist through their own monitor. What made this supremely annoying was that your credit score was--and is--a major indicator of your financial life. Not knowing your credit score and trying to plan things like mortgages and car purchases is like not knowing your weight, blood pressure and cholesterol levels and trying to manage your health. A good credit score can save you enough money (through lower interest rates) over the life of a 30-year mortgage to buy a whole new house.

What a difference a few years makes. While misinformation still exists on the Internet and elsewhere, consumers now have authoritative, easy-to-understand sources of information to turn to to acquire, understand, and manage their credit scores. For starters, you can order real Fico Scores/Reports
online by clicking the link in this sentence.

Think you're already getting FICO scores? Maybe, maybe not. Unfortunately, there are many non-FICO credit scores offered by banks and other vendors that are not the same as FICO scores. These scores often deviate from FICO scores by dozens, sometimes even around a hundred points. Since mortgage lenders, car loan providers, credit card companies, and most other creditors use FICO scores, FICO scores are the scores you want to obtain. If you currently get a "credit score" for free with a checking account, credit card, or other service, chances are it's not a true FICO score and therefore is not indicative of where you actually stand with prospective lenders.

The FICO scores available via the link above come with a copy of your credit report. Moreover, the score reports also contain detailed, easy-to-understand annotation that tells you why your score is where it is, and what you can do to improve it. Gone are the Magic 8-Ball type cryptic numbers and code-words.

As part of my effort to educate consumers on how to profit from the current economy, I have put together a Web site (and I'm talking a real site, not some crappy link farm) called www.allaboutthebenjamins.org that gives detailed information on FICO scoring. The site shows you how to improve your FICO score yourself without resorting to gimmicks or costly and often ineffective credit repair services. My site helps you improve your score by enabling you to understand and correct the factors that lower it rather than applying Band-Aid "solutions" like renting other people's lines of credit.

Once you've ordered your scores and checked out my Web site, continue on to the FICO Forums, which contain the most well-informed user base on the planet concerning FICO scoring and credit issues in general. Overstating just how knowledgeable and willing to help the denizens of the FICO Forums are would be rather difficult; there are some Vulcan-class brains over there.

This is the Information Age. Be informed, and take command of your credit. We're coming up on some unprecedented opportunities to buy housing on the cheap, and you don't want to be left out.

Are Interest Rates Headed Up? Should I Care?

What is interest, anyway?

I'm starting this post with a definition of interest, because many folks out there on the fruited plains don't really understand what interest is, what affects interest rates, and how interest rates affect us. To most people, "interest" has acquired a negative connotation, as it denotes the extra we pay to borrow money. Increases in interest rates tend to bring groans, and decreases, relief.

The definition of interest is simple: interest is the cost of money (specifically, using someone else's money). When you borrow money, you are "renting" the money in the same way you "rent" a DVD or car. You are using something that belongs to someone else, for a set period of time, and paying them for the privilege. The price you pay depends on market conditions (usually the costs incurred by the provider in bringing the product to market and maintaining it). In the case of renting a car, the rental company has to maintain the car, takes a hit on depreciation, and runs the risk that you'll wrap it around a telephone pole. Those costs, plus the company's profit margin, are factored into your rental rate.

The same overall set of forces drive the price of money, but there are some differences. One of the major determinants of interest rate is the level of risk involved that the borrower will default and the lender will be unable to recover its loan. This is why a consumer with a high credit score putting 10% down on a new house can secure a low interest rate: the consumer has shown him or herself to be trustworthy and reliable, and if push comes right down to shove and the borrower gets hit with a garbage truck, there's still the house itself as collateral. So the lender can get away with a small risk premium.

Another factor determining interest rates is inflation, which is something Netflix doesn't have to worry about. The value of that copy of I Am Legend that you rented on Tuesday isn't going to change significantly by the time you return it on Saturday. Not so with money, especially over time. If you're over 40 or so, you know exactly what I'm talking about. In the Seventies, you could do dinner and a movie with your sig.other on $20. Now movie tix and popcorn alone would run close to $25. So, if you loan someone $100,000 today, charge them 4%, with the loan due in 2018, you're not going to make 4%, because the value of those loaned dollars is being chipped away at every year by inflation. In fact, if inflation runs at 5%, even if the loan is repaid as agreed, you've lost money, because the dollars you were owed were depreciating more quickly than the interest you charged was adding up.

So how do lenders know what inflation will be like the next ten years? They don't. But because interest rates factor in inflation, they also factor in the big banks' guesses at to what inflation is going to be doing. Because there are billions of dollars on the line, you can bet banks have some of the best economic minds on retainer to game out where interest rates are headed, but after all is said and done, it's only an educated guess. They could come out ahead...or behind. But the moral of the story is, when long-term interest rates start going up, that's a signal that the Big Boys expect more inflation down the road. On the other hand, if long-term rates remain low, that means the banks are relatively unconcerned with inflation down the road.

There's a third factor figuring into interest rates, and that is the Federal Reserve. The role the Fed plays in the economy is too complex to go into here, but for the purposes of our discussion, think of the Fed as a reservoir of money, upstream from the rest of the economy. As a reservoir serves to moderate the flow of the river downstream, so the Fed moderates--or tries to moderate--the economy. When the economy runs too slowly (the "river" starts to dry up), the Fed opens the spillways and releases money. When the "river" runs high, and "excess" growth threatens to spur inflation, the sluice-gates are constricted, and the Fed draws more money to itself.

Operationally, what the Fed does to loosen or tighten the flow of money is to lower and raise, respectively, the interest rates it charges to the banks. The Fed also engages in what are called open-market transactions, selling U.S. Treasury bonds to suck money out of the economy when it wishes to tighten the money supply, and buying bonds to sluice money back out. These measures act, usually quickly, to affect the prime rate, which is the interest rates the banks charge their biggest, best, most reliable customers. Most other interest rates are pegged to the prime (with some level of markup), so changes in the prime rate richochet rather quickly through the economy.

However, mortgage rates are relatively insensitive to the prime rate. Why? Because mortgage rates are a 15 to 30-year "bet," the "odds" on the table today really don't matter much to mortgage lenders. (A nominal exception to this are ARMs (Adjustable-Rate Mortgages); since interest rates can be adjusted over time, the initial rate does more closely correspond with current market conditions.) The 30-year fixed mortage interest rate offers the average consumer the best look at what the experts (the ones with a lot of casino chips on the table) see as the future of the economy.

So when you see the 30-year fixed rate increase sharply, you should be seeing a red flag. Such an increase means that the Big Boys see trouble over the horizon (higher inflation, more economic uncertainty, a possible nosedive causing higher defaults that need to be factored into the risk premium, etc.).

This is why I have a widget posted in the right column of this blog, tracking interest rates over time. In fact, it shows the very phenomenon I've been alluding to. Note how the ARM rates have been fluctuating around a mean, whereas long-term rates have noticeably increased over the last six months. In fact, the 30-year fixed rate has gone from around 5.9% in March to 6.35% at the end of last week.

How worried should we be? At this point, I don't consider the increase to be overly alarming. Recall that we have been operating for several years in an environment of unusually low interest rates. Through much of the Nineties, 30-year rates fluctuated between 6.5% and 9%. So the increase to 6.35% isn't much to get worried about--for now.

However, this statistic bears watching, as further run-ups in the 15 and 30-year rates could mean that knowledgeable people in high places see trouble up ahead.

Welcome to California

Please observe the no-smoking sign, as our state is already on fire. Thank you.

Just for grins and giggles, here's the page listing all of the NOAA weather warnings in effect for our great state at the moment. My patio thermometer still reads 107 after an excursion past 110 this afternoon.

Just Make a New Plan, Stan

As the Fourth of July holiday recedes, and the election season shifts into high gear, The Plans are emerging from the McCain and Obama camps. Don't worry, America, the candidates tell us, we have...a Plan.

In keeping with political neutrality, I'm not going to go through the candidates' plans and pick them apart, nor say which candidate or party I recommend. That's not what this is about. My thesis is far simpler than saying McCain's plan won't work because of this, or Obama's plan will fail because of that, or liberal this or conservative that. To me, that's like arguing over the placement of deck chairs or the musical accompaniments on the Titanic. It's worse than futile, because it distracts us from the real dangers we face: time spent arguing over these trivialities is time one could be spending finding a lifeboat or at least a piece of furniture that will float.

Instead, I'll just cut right to the chase, and say that neither Obama's nor McCain's plan are going to fix what's wrong with the American economy. Why is this? "How can you so cavalierly dismiss the plans," you ask? I can and I do, because the candidates are not addressing the underlying issues afflicting the American economy. Since the Seventies, if not before, we've based our economic policy on the following set of assumptions:

1. We can consume more than we produce, and continue doing so indefinitely. This is probably the root of most of the other issues. For decades now, Americans have bought more from the world than the world buys from us. We've spent more than we've made, especially in the public sector.

2. Free trade is always beneficial, no matter how uneven the playing field. It's that last half that's the trouble. Free trade with our industrialized peers is fine. Free trade with nations that use slave labor--that's another story. Competition is good, but any competition has to have rules that apply to both sides. There's a difference between competition that's fair and which makes you work harder and improve (like when our auto industry was forced to reform by Japanese competition), and a football contest where your opponents get to wear chain mail and carry maces (like "competing" with Chinese slave labor whose products are artificially cheapened by a devalued currency). The reality is that free, fair trade is beneficial.

3. Cheap oil is a national birthright, and no matter how much we use, we'll always find more...and more...and more. This is a classic human failing, confusing abundant with unlimited. Abundant is not unlimited. We found that out the hard way with the passenger pigeon, which once existed in flocks of billions of birds, some such gatherings being hundreds of miles long. As of 1914, the passenger pigeon was extinct. How could that happen? People assumed that, because the passenger pigeon was abundant, it was unlimited, and they could hunt as many as they wanted as often as they wished. They likely thought Earth would magically produce more. It didn't.

4. The market always knows best. Don't get me wrong: I believe in free enterprise and private property as the foundation of a solid economy. The 20th century showed conclusively that private enterprise, not the State, is the most efficient engine a society can rely on to produce economic growth. But the market is a playing field, and ball games need some rules and referees. Note that I said "some." You don't see ball games with more umpires and referees on the field than players, and likewise over-regulation is a bane to economic progress. But there's no question that excessive deregulation of the financial sector aided and abetted the mortgage crisis. Loans were made that should not have been made. Low-grade shady paper was repackaged and passed off to investors as prime-grade securities. Banks were allowed to lie to shareholders by reducing payments on mortgages to try and keep borrowers from defaulting--yet could still report full payments on their books. The whistle should have been blown three or four years ago.

If you examine the candidates' plans, none of them comprehensively address these issues.

The standard lip service is paid to #1...there's not a candidate who has run for President since the Seventies who doesn't promise to balance the budget. We're now $10 trillion in the hole and counting.

#2, which has decimated our manufacturing base and contributed the most to the decline in the standard of living of American workers, is barely even mentioned.

#3 is getting some attention, but the predominant thought pattern remains that either the oil companies are bilking the public and manufacturing the shortage, or that environmentalists are the only thing standing in the way of America exploiting the big gobs of crude oil off its coasts and becoming the next Saudi Arabia. Token measures are advocated to support R&D into alternative energies.

We are in an unfolding crisis, and token measures aren't going to cut it. When World War II was raging and two hostile regimes threatened us, Roosevelt didn't say he was going to look into the idea of harnessing nuclear energy for military purposes, and bump up R&D over the next five to ten years. No, he got the best minds in the country together, gave them a budget with teeth, placed all the resources of the United States at their disposal, and told them to find the answer--and yesterday! The candidates today pledge nickels and dimes when what we need is a new Manhattan Project.

#4 is getting some attention, in that some of the worst deficiencies that permitted the mortgage crisis to unfold are finally being looked at...kind of like fixing up the barn and upgrading the quality of the hinges on the door after the horse is long gone. It's a start, but only that.

So, what can we as citizens do about all this? This blog doesn't make partisan political recommendations, but I will say that, when leaders refuse to lead, it's up to citizens to take the initiative. The change that's coming in this country is going to be bottom-up, not top-down. We can each take some steps to address those four issues on a personal, microeconomic level.

#1: Get your own finances in shape. Cut spending. Consider lifestyle changes. Let's face it: much of what we Americans spend money on are wants, not needs. While some of us are facing an inability to pay for basics (rent, food, electricity) despite good financial stewardship, many of us are in financial binds that are, at least to an extent, our own doing. We pay $25,000 for an $18,000 car when really we could have gone to a used car lot and paid $8,000 for a $7,000 car that would have done what a car is supposed to do: get us from point A to point B. We eat out and pay $20.00 for a meal we could have made at home for $8.50 (this is one of my personal weaknesses).

#2. We can't personally affect trade policy...or can we? If we buy less, then we import less. If we buy a couch for $75 at a secondhand store versus $750 at a furniture store, we save $675 and reduce our trade deficit by several hundred dollars. If we buy our children quality toys that make them think rather than showering them with cheap plastic crap, we reduce imports.

#3. We can vote with our wallets for alternative energy. We can drive less, and bike, walk, and take the bus more. Check your local utility: many allow you to specify that your energy is to come from wind, solar, and hydropower and pay only 3-5% more. And lowering consumption (see #2) reduces fossil fuel use.

#4. We don't have much power to affect this issue directly, but we can choose as individuals to lead ethical and prudent lives. We can take a look at what people propose to us and decide if it sounds too good to be true, it probably is.

The candidates don't have viable plans to fix what ails the country, so I suggest to everyone out there that you come up with your own personal and family plans to downshift and localize your lives.

Can't We Have Some GOOD News?

The past several months certainly have not been for the light of heart. Between the housing crisis, the ongoing massive run-up in oil prices, and rising unemployment, economics has duly earned its moniker as "the dismal science." I haven't seen many bell-bottoms yet, and there's still nary a leisure suit to be found in public, but these days are otherwise feeling more and more like the Seventies with each passing suckflationary week.

So is there any good news to be had? The answer is, yes...though some of it you may have to make for yourself.

Good news: the commuter culture is coming to a close. Finally, the utter insanity of spending the equivalent of an entire waking day in an automobile each week going to and from work so you can (among other things) pay for the gas to make the trip is being exposed for all to see. Fathers might actually start arriving home in time to do something other than nuke a microwaveable dinner and tuck their kids in. We might actually (gasp!) get home from a day's work while there's still daylight, at least March through October or so. Families might actually start spending time together again. Family dinners, anyone?

Good news: energy conservation and alternative energy are finally being taken seriously. Even when gas was $1.78 a gallon, deep down inside we all knew it couldn't last. Someday we knew the cheap ride was coming to an end. Yet it was all too expedient for politicians to punt the ball and leave solving the problem to future generations. Now the ball has come to rest. Sure it's painful, but finally the foundation is being laid for America to have an energy source that doesn't enrich people who hate us, doesn't pollute, and that will last forever. That source is likely to be thermonuclear fusion (unless there's a real technological breakthrough and we come up with cold fusion, zero-point energy, or total mass conversion). The technical hurdles to harnessing any of these energy sources are formidable, but even a journey of a thousand miles begins with a single step. Despite the malingering of two generations of politicians, that step is now being taken.

Good news: our cities and towns are going to be reinvigorated. As life becomes more local, people will be looking more and more to the communities they live in for entertainment, recreation and economic sustenance. Look for fewer anonymous, cookie-cutter suburbs, and more vibrant city plans that mix residential and commercial development. After virtual extinction during the automobile-driven mid-to-late 20th century, the concept of civic space is experiencing a renaissance. Local forms and venues of entertainment--harvest festivals, farmer's markets, county fairs, carnivals, Christmas festivals, small dance halls, bowling alleys, movie theaters, local attractions, even libraries--the localization of our lives in the next decades will breathe new life into these venerable American traditions. One man who has minced no words about these trends is James Howard Kunstler.

Good news: our food is going to become more nutritious. Why? We'll be growing more of it ourselves and relying less on mass-produced, processed mega-foods. Prices may be zooming at the grocery store, but raising your own fruits and veggies isn't much more expensive than it was ten years ago. Even an apartment balcony can grow a surprising amount of food. Enterprising locals are making money selling tomatoes to local restaurants since salmonella fears have severed conventional supply lines for this ubiquitous food.

If you have a yard, even a small one, growing a garden opens up all kinds of possibilities for not only your own sustenance, but bartering with neighbors for their produce or even other goods and services. Now would also be a good time to plant fruit trees, especially citrus and other tropical fruits, as these take several years to become productive. Even if they have to be grown indoors in pots because you live in a cold climate, they can be nurtured with highly efficient shop lights, and moved outside when danger of frost is past.

Good news: more and more of us will be going to four-day workweeks and telecommuting. With gas costs soaring, the idea of working from home and working a four-day week is gaining increasing acceptance. While some people may chafe at more regulations, as gas goes past $5 a gallon and the need to conserve fossil fuels becomes a matter of national security, we may well see government applying pressure to business to reduce the workweek and shift workers who could work remotely back home, at least one day a week.

The math makes compelling sense: say a city has 100,000 commuters. 50,000 of these could be shifted to a four-day week. 25,000 could also telecommute one day a week. So that's 150,000 commutes a week that don't need to happen (counting to and from work). Figuring from a base of one million commutes a week, that's a 15% reduction in commuter traffic. If each commute burns a gallon of gas, that's 150,000 gallons a week, which translates into a savings of $750,000 a week, or $39 million a year those commuters could save or drop into other parts of the local economy. Those numbers were easy to blow off during prosperous times when gas was cheap, but will become increasingly difficult for policymakers to ignore as gas prices climb.

Good news: our air is going to be getting a little cleaner. As gas prices rise and people drive less and shop less, that translates into fewer car trips, shorter car trips, and fewer truck-miles. People will also have a stronger incentive to retire old, gas-guzzling, high-emission vehicles and replace them with newer, low-emission vehicles. That in turn means less air pollution.

Good news: we're going to be getting into better shape. The bicycle, often arrogantly dismissed outside of college campuses as the means of transport of paupers over the past couple decades, is coming back into style. Look for more bicycles to be made, and for cities and towns to increasingly take bicycle and pedestrian traffic into account when planning cities and making changes to existing plans. Once the public feels the numerous benefits of physical exercise, look for bicycling to nearby attractions to become an outing and leisure activity in its own right.

Good news: home improvement, home decorating and home design will be growth industries. We're going to be spending less time getting away from home, and more time enjoying our homes. Thus, home will once again be the hearth, the focus of familial activities. The drive to make the home a place to live rather than spend the year commuting away from it and the summer vacationing away from it will strengthen over the next decade. Saturday afternoon barbecues and Christmas dinners will return. Everything from exotic plants to softer furniture to PlayStation 3s will be in demand as more nights and weekends are spent "in."

Good news: normal people will be able to own homes again. After two decades of housing prices absurdly inflated by cheap commutes and easy credit, pricing is on its way back down to Earth. The housing bubble still has quite a ways--at least another year or so--to deflate, with rising gas prices, layoffs and more foreclosures on the way. Even renters will see some relief, as homeowners "on the margins" of foreclosure rent out rooms and their second homes that they can't unload at anything close to the rate they paid for them, thereby increasing the supply of rentals and decreasing the price.

Good news: political reform will come sooner rather than later. I think we'll see changes across the board, but the area I'm thinking of is how we treat the poor. America has become polarized into two camps. The first camp, often referred to as "conservatives," believes the poor are poor because they want to be, and that sharing resources is bad because that will just encourage poor people to be lazy. The fact that many of these poor are in fact working seems to matter little to people on this side of the issue. The second camp, often referred to as "liberals," believes that is we take money from somewhere, create a bureaucracy, and hand out money from on high, the poor's predicament will be resolved. The dismal record of inefficiency most social welfare programs have doesn't factor in to these folks' calculations.

The 20th century showed us neither scorning nor subsidizing the poor seemed to work too well. The coming decline will force us to look beyond these ossified notions, because there are going to be too many poor people to just ignore, and the government, already hip-deep in debt, isn't going to be in a position to offer much more aid than it already does. I don't claim to know exactly what solution will be arrived at. Given that the political Establishment seems to be without a clue as to the kind of world we're headed for, my educated guess is that this new approach will be communal, bottom-up, grass-roots driven, and do an end run around conservative and liberal politicians alike. By 2012, I predict the American two-party duopoly is going to come under unprecedented pressure to do something it's quite unaccustomed to: stop posturing and start delivering results.

Good news: we're going to be slowing down. Cheap oil and easy credit energized our lives and helped us move faster, but somehow we just never got ahead. We couldn't ever get where we were going quite fast enough. If we moved a little quicker, the clock just seemed to speed up a bit, and we ended up just as far behind. But if we have fewer places to go and less ability to get there, it stands to reason we'll be racing the clock less, and stopping to enjoy life a little more.

The unchallenged control the clock holds over us Americans is actually a fairly recent invention. For 99% of the human race's history, the time of day was "sunrise," "morning," "noon," "afternoon," and "gonna be dark soon." I'm not seeing us return to that level, but I do believe the pace of life is going to shift to a lower gear as we focus less on where we "have to" be, and more on where we are.

Good news: the concept of community is going to undergo a revival. As our lives become more local, and we focus on where we are, we're going to begin to notice (as our elders did a couple generations ago) the people we share that locality with: also known as neighbors. The block party is going to come back into vogue, as is the park where kids used to play kick-the-can, trick-or-treating on Halloween, and so forth. This represents another downshift in political culture, as the nation and state, strapped for resources, recede into the background and the community and town become more important...as they once were.

Good news: spirituality is going to experience a revival as well. It's a truism noted throughout human history: during prosperous times, people turn from the spiritual to the physical, and when times get hard, people look for spiritual answers to the questions of life. (In the interest of being nonpartisan and unbiased, I'm not going to speculate here which specific spiritual traditions and faiths will enjoy growth--at this point in time, it's too early to tell anyway.) Likely it will vary widely by location and culture, because during the era of cheap, global travel, we imported quite a few faiths and traditions, and America has developed some of its own.

All of this isn't to say that we're not going to be having some trying times ahead. We're headed for turbulence the likes of which we haven't seen since the 1930s. That old Chinese curse, "may you live in interesting times," is definitely coming to fruition. Our nation may not survive, if things go badly and (more importantly) if we react badly. We could see America splinter into regions a la Jericho, if too many people opt for a "last man standing" war over dwindling oil and resources. But it doesn't have to be that way, if we keep our wits about us and see the positive in the changes that are to come.