The money book for the young, fabulous & broke

Riverhead Books

Chapter One

If you forced me to pick one single bit of advice that would have the biggest impact on turning around your financial situation, I wouldn't hesitate for a second. You have to know the score: your FICO score.

Just about every financial move you will make for the rest of your life will be somehow linked to your FICO score. Not knowing how your score is calculated, how it is used, and how you can improve it will keep you broke long past your young-and-fabulous days.

Yet I also know that you are probably FICO-ignorant; I get a 90 percent failure rate when I ask YF&Bers if they know their FICO score or why it is so important.

That's got to change. Right now.

FICO FUNDAMENTALS

A Fico score is a three-digit number that determines the interest rate you will pay on your credit cards, car loan, and home mortgage, as well as whether you will be able to get a cell phone or have your application for a rental apartment accepted. FICO stands for Fair Isaac Corporation, the firm that created the formula that seems to lord over your financial life. The way the business world sees it, your FICO score is a great tool to size up how good you will be at handling a new loan or credit card, or whether you're a solid citizen to rent an apartment to. A high FICO score gives you a great reputation with the business world; you'll get the best deals. A lower FICO score translates into paying higher interest rates on cards and loans. Your credit history can even affect your auto insurance premiums or your ability to get that job you applied for. I wasn't kidding when I said it was connected to just about every part of your life.

With so much on the line, I hope it's clear now that you can't afford to stay FICO-ignorant.

Your FICO score is based on your spending and bill-paying habits, and your overall debt load. I know this might come off as a bit of disturbing big brotherism, but nearly every financial decision you make is being watched, tracked, and massaged, with the goal of determining your financial profile. The folks you do business with, from lenders (school loans, auto loans, mortgages] and the phone company to credit card companies, constantly file reports on your financial activity to one of three major credit bureaus. These credit bureaus know what you have spent, what you owe, and if you tend to pay bills on time or let them slip. From all that raw personal data, the three credit bureaus calculate your FICO score using a formula developed by Fair Isaac.

Fair Isaac and the credit bureaus make a ton of money sharing your FICO score. Mortgage lenders, auto lenders, employers, cell-phone companies, and insurance companies are happy to pay up to get a glance at your FICO score. They use it just like colleges used your SAT score. It helps them assess whether they want to accept your application, or what terms they will offer you. To the financial world, you are your FICO score-plain and simple.

THE FICO FORMULA

Fair Isaac sorts the data from the credit bureaus into five broad categories that have varying degrees of importance in calculating your FICO score. Don't worry, this is not going to require dusting off your calculus textbook. It's fairly straightforward.

Your ... Accounts for this percent of your FICO score

Record of paying your bills on time 35

Total balance on your credit cards and other 30 loans compared to your total credit limit

Length of credit history 15

New accounts and recent applications for credit 10

Mix of credit cards and loans 10

On pages 29-32, I explain what moves you can make to boost your score on these five key elements.

YOUR FINANCIAL LIFE REDUCED TO THREE DIGITS

After massaging all that info, Fair Isaac uses a formula to come up with a score for you that can range from 300 to 850. Anything between 300 and 500 means you are a toxic financial risk and you are going to be hard-pressed to find any business that will want to work with you. Scores between 500 and 850 are sliced and diced to fall into six ranges; the exact cutoffs for those ranges can vary from lender to lender, but typically this is what you may encounter.

So your goal is to get your score into the 720-850 range. The good news is that someone with a score of 721 can get just as good an interest rate on an auto loan as someone with an 849. That's true within every score range.

A MATTER OF INTEREST

The range your score falls into ultimately determines the interest rate that you will pay on loans. Other factors, such as your employment history and salary, will also affect the deal you get, but your FICO score is a major component in determining the interest rate you will end up paying for a home mortgage or car loan.

720-850 700-719 675-699 620-674 560-619 500-559

30-year fixed- 6.0% 6.1% 6.7% 7.8% 8.9% 9.5% rate mortgage

720-850 690-719 660-689 625-659 590-624 500-589

Four-year 5.1% 5.9% 8.0% 10.5% 14.4% 15.8% auto loan

The rates above were effective in the fall of 2004. But regardless of what current interest rates happen to be as you are reading this, the difference between the highest and lowest of the acceptable FICO ranges is going to remain constant: about 3.5 points on a home loan and more than lo points on a four-year auto loan.

If percentages don't do the trick for you, let's convert some of this into cold, hard cash. On a four-year, $20,000 car loan, we're talking about paying an extra $103 a month if your FICO score is in the 500-589 range rather than the top range of 720+. That's $1,236 a year, which comes to $4,944 over the four years of the loan.

I think those are 4,944 very good reasons to care about your FICO score.

FIRST STEP: GET ALL THREE CREDIT REPORTS

Since your FICO score is a calculation based on the history in your credit reports, your first job is to make sure everything in those reports is correct. Don't assume a thing. The rate of mistakes is sickening.

The big three credit bureaus are Equifax, Experian, and TransUnion. You can get the reports online at annualcreditreport.com, or by calling 877-322-8228. And you need to check all three. In a clear case of "nothing is simple," each credit bureau receives different info about you from different sources. For instance, your credit card may report to Equifax but not TransUnion or Experian. Or your cellphone provider may report to TransUnion but not Experian or Equifax. The result is that you have three different reports, all containing different information. You want to make sure all three are sparkling. (By the way, this also means that you have three FICO scores, not just one. But let's not get bogged down with that just yet.)

By the end of 2005, every consumer will be able to get one free report a year from each credit bureau. This is your credit report only; your FICO score is a separate step we will get to in a minute.

If you don't see your state in the freebie phase-in schedule below, it means you can already get your report at no cost. Otherwise, you need to wait till the dates below, or pay about $9 per report from each bureau now.

FREE CREDIT REPORT SCHEDULE

June 1, 2005 Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Mississippi, Oklahoma, South Carolina, Tennessee, and Texas

Sept. 1, 2005 Connecticut, Delaware, District of Columbia, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Rhode Island, Vermont, Virginia, West Virginia, Puerto Rico, and all U.S. territories

CORRECTING YOUR CREDIT REPORTS

If you have errors on your credit report, please know that you are in good company. A recent survey by the U.S. Public Interest Research Group found that 25 percent of reports have serious errors, 30 percent listed "old" accounts that should have been deleted, and 79 percent overall had some sort of mistake or error. You can file a dispute with the credit bureau (again, go to their website or call their 800 number to set the record straight), but I am not going to sugarcoat this; it can take a long time to sort through most of the problems and have the erroneous information removed from your record.

Technically, the credit bureau has just thirty days to process your challenge and get back to you with a response. But all that means is that they must contact the company that supplied the data-say, a department store, credit card company, or auto dealer-and ask them to verify the information. In thirty days you may hear back that the credit bureau is keeping the information on your record because the company that charged your account says it was a legit charge. If this happens, you must start dealing directly with that business.

Some good news is that a new federal regulation that went into effect in December 2004 ensures that any business that you are in a dispute with about a charge must share information with you and promptly investigate the problem. As reasonable as that sounds, it clearly has not been the case for many people who have tried to clear up problems. Contact the business's customer service department to request help in investigating your disputed charge.

Another possibility is that you may find that the "mistakes" on your report are actually the handiwork of an identity thief. Don't panic, and don't beat yourself up about it. This is pretty much a national financial epidemic. On pages 36-37, I discuss how to deal with identity theft problems.

GET YOUR FICO SCORE

After you have your credit reports and have taken care of clearing up any mistakes, you are now ready to get your FICO score. Remember, though, that I mentioned that you actually have three FICO scores, based on the different data supplied by each credit bureau. So that can make life expensive, because the charge for one FICO score (which automatically includes a credit report) is $14.95.

But don't worry. Unless you are buying a house, there's no reason to get totally FICO'd; you only need to pay for one score, not all three. If you are simply checking your score, take your pick of any of the three. Now, if you are planning to apply for a loan, you need to be a bit more strategic. Typically, a lender you go to for an auto loan or credit card will check just one of your FICO scores. So you want to call them before you apply and find out which FICO score-compiled from the information from Equifax, Experian, or TransUnion-they will use. That's obviously the score you want to check yourself before applying for the credit card or loan.

Here's some trade lingo to help you understand which credit bureau is being used: If the lender says it uses the Beacon score, that means it's Equifax. If they say Empirica, it means riley use TransUnion. The Experian name is self-evident-it's Experian/Fair Isaac Risk Model. A mortgage gets a bit trickier. Because this is such a huge financial responsibility, mortgage lenders are going to check all three FICO scores. So in this instance, you need to cough up the money to check all three of your FICO scores. But hey, spending $44.85 to make sure you're in good shape for landing a six-figure mortgage isn't asking much.

I need to stress how important I think it is to make sure you get an actual FICO score. There are other credit scores available for just a few dollars, which I know look tempting compared to the cost of a real FICO score and credit report. But saving seven or eight bucks can end up costing you a ton. The problem is that those other credit scores aren't what the majority of lenders and businesses use when checking your history to decide if you are a good credit risk, and those scores can be off by as much as 50 to 100 points from your real FICO score. The FICO score is the industry standard. Consider this scenario: You want to buy a house. So you pay $5 to check your score at one of the "other" services. Everything looks fine, so you go ahead and apply for a mortgage. But when your mortgage lender checks your real FICO scores, they aren't as good as you expected, and you end up getting stuck with a higher interest rate on your loan. That could cost you thousands of dollars in extra interest payments. All because you wanted to save a few bucks by not paying for a real FICO score.

STRATEGY SESSIONS

PROBLEM:

There is so much conflicting advice on how to improve my FICO score.

SOLUTION:

Focus on what matters to the FICO folks.

Your goal is to do everything possible to please the FICO gods. As the table on page 23 shows, there are five key areas that affect your score. So let's just focus on those five areas, in order of importance.

1. PAY ON TIME

Your track record in making timely payments accounts for 35 percent of your FICO score. Notice I said nothing there about paying a load of money. All that is required is that you pay the minimum balance due on time. That shows that you are responsible. The longer you manage to be on time, the better your FICO score will be.

Now let's review what qualifies as "on time." Writing the check on the date it is due is not on time. Nor is sending it in three days late but backdating the check. Cute just doesn't cut it.

I want you to write the check and put it in the mail at least five days before your due date. Or if you use online bill pay, make sure you get to it at least two days before the due date. As far as I am concerned, online bill pay is a smart YF&B move. You sit down once a month, and with a few clicks you can have all your bills paid automatically, including your credit card. Just do me a favor: If you have a PDA and use the calendar feature, give yourself a reminder a good three or four business days before the credit card bill is due to sit down at your computer for fifteen minutes and authorize all your online bill payments.

2. MANAGE YOUR DEBT-TO-CREDIT-LIMIT RATIO

Your next challenge is to see if you can reduce what is known as your debt-to-credit-limit ratio. Your debt is the combined balances on all your various credit cards and installment loans-the sum of what you owe. Your credit limit is the combined total of the maximum amount each credit card company is willing to let you charge. This calculation plays a big part in determining 30 percent of your score. (Included along with that calculation is whether you carry balances on other accounts, and how much debt you have left on loans such as a mortgage or car loan, compared to the original amount borrowed.)

Continues...

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Excerpted from The money book for the young, fabulous & broke by SUZE ORMAN Copyright © 2005 by Suze Orman. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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