photo credit: Andrew 94

Yesterday’s NY Times contained an article on how the credit card industry plans to make up for lost revenue.

Credit cards have long been a very good deal for people who pay their bills on time and in full. Even as card companies imposed punitive fees and penalties on those late with their payments, the best customers racked up cash-back rewards, frequent-flier miles and other perks in recent years.

Now Congress is moving to limit the penalties on riskier borrowers, who have become a prime source of billions of dollars in fee revenue for the industry. And to make up for lost income, the card companies are going after those people with sterling credit.

Banks are expected to look at reviving annual fees, curtailing cash-back and other rewards programs and charging interest immediately on a purchase instead of allowing a grace period of weeks, according to bank officials and trade groups.

I’m one of those people who pays my bill in full and I LOVE getting all those frequent flyer miles each month.  Getting miles or cash back is definitely a perk so while I would be disappointed if they went away, I would still use credit cards for the convenience factor.  However, I draw the line at paying interest and refuse to do so.  I suspect a lot of card companies will lose customers when/if they make that change.  How will these proposed changes affect your credit card usage?

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In 2008, many credit card holders were shocked to find their credit limits getting slashed so dramatically and that trend has only continued into 2009. There is a variety of reasons why credit limits have been getting reduced, including account inactivity but also because of changes to the credit risk profiles of so many cardholders that have changed as the direct result of the dramatic downturn in the economy.

Cards that have remained inactive for long periods of time were the first to go. Michael Riley, a software engineer from Denver and a long time customer of J.P. Morgan Chase, just received his second cancellation notice. “I just got a notice from Chase last week that my platinum card was being closed because of inactivity.” Riley hadn’t used the card for over a year but was miffed at the thought of losing an account that he had held for so long. “That was one of the first credit cards that I ever got right after college.” Many cardholders have shrugged off these account closures because most people don’t believe they will be affected by a card that they never use. Out of sight, out of mind, right? But another problem has emerged from these account closures that many people are unaware of.

These sudden account closures are also negatively affecting FICO scores for countless numbers of cardholders. FICO scores are computed utilizing several factors, including payment history, credit utilization, new credit accounts, types of credit being used, as well as the length of the credit histories. When an account is closed, it can dramatically affect the credit utilization score of a user. For instance, a cardholder with a $5,000 card balance on a $12,000 card limit and a zero balance on a $13,000 card limit has a total credit utilization ratio of 20%. But if the card issuer decides to close the account with the $13,000 limit because of “account inactivity”, that cardholder’s utilization ratio will jump up to 40% – in an instant. Credit utilization accounts for roughly 30% of the total FICO score so a jump in utilization from 20% to 40% can have a devastating impact on a credit score in a very short period of time.

“My credit score went from 785 to 668 in less than 90 days and I’ve never been late with a payment,” said Craig Woodside, a plumbing contractor in Trenton, New Jersey. “The only thing that changed in those 90 days was Citibank closing one of my old credit card accounts.” Another credit scoring factor that is negatively impacted by an account closure is the length of your credit history. Cardholders with accounts they have held since college, which are being closed for inactivity, wind up losing the entire credit history on that account. Some cardholders have had accounts closed with more than 20 years of credit history. With length of credit history accounting for about 15% of a total FICO score, these types of account closures, seemingly harmless at first glance, are really hurting people’s credit scores in a big way.

So, faced with the prospect of a drastic drop in credit scores, what can you do about this particular problem?

There are a few things that you can be proactive about in order to keep your account off of a card issuer’s chopping block. First, make sure that you maintain activity on the card, even if it’s just the bare minimum. You might consider setting up an auto-payment with the card for a utility bill, magazine or newspaper subscription that you know you’re going to have to pay each and every month. You don’t have to go out and overspend frivolously with the card (like so many people do with their rewards cards) – just keep the card active.

Next, make a preemptive call to your card issuer. Be sure to indicate your desire to maintain the account and ask if there’s anything that you need to be aware of (besides making your payments on time) or other things that you should be doing to keep your account in good standing. Make sure that the customer service representative notates your desire to keep the account in your file and be sure to indicate to the representative that you will maintain activity on the card.

And finally, if you haven’t started paying down those card balances just yet, now is the time to do it. Cardholders should aim for a credit utilization ratio of no greater than 30% on any individual card and in total. Paying down those card balances aggressively and driving your utilization ratios downward will have a significantly positive effect on your credit score in a short amount of time.

1. Create a budget – Know how much money you bring home and how much you spend. If you are unfamiliar with how to create a budget, many credit unions offer free financial literacy classes.
2. Vow to spend less than you make – Nothing makes more sense than living within your means. If you are constantly overspending, you will never have enough money to save or invest.
3. Watch every penny – Dropping unnecessary services and avoiding ATM fees are just a few of the ways you can find some extra savings. Many credit unions offer free access to thousands of ATMs through participating networks.
4. Review your credit record/financial statements regularly – Request a free copy of your credit report once a year at www.annualcreditreport.com. Scrutinize your financial/credit card statements regularly to ensure that identity thieves are not running up charges in your name. Report any questionable charges immediately.
5. Reduce your debt – Assess your outstanding debt and make a plan to reduce your balances. You might also consider consolidating your debt. With consistent payments above the minimum, you can reduce your debt significantly.
6. Plan ahead – In everything from vacations to holiday shopping, it pays to plan ahead. How about starting a vacation or holiday account to fund those big purchases? At many credit unions, you can open an account with as little as $5.
7. Start an emergency fund – Unexpected events like an illness and an auto or appliance repair often require big money. Most financial advisors recommend saving three-six months’ expenses to fund these items.
8. Make your money work for you – Credit unions offer competitive rates and great service in a broad range of products including savings and checking accounts. Many credit unions also offer online services. Go to www.culookup.com to find a credit union you may be eligible to join.
9. Use credit cards smartly – Get a credit card with a low annual fee or with rewards that suit your interests and remember to pay your bills on time. Consumer Reports recently found that credit unions offer some of the best credit card rates. For example, credit cards and all loans issued by federal credit unions cannot exceed 18 percent. In fact, the average interest rate was about 11 percent on credit cards from federal credit unions in December.
10. Protect your family and your assets – Make sure you have enough insurance coverage for your property as well as yourself and your family. Make a will if you don’t already have one. Shred financial documents and/or credit card offers before throwing them out to avoid revealing personal information unnecessarily.

Are you a member of a credit union?  If not, I would suggest looking into it.

photo credit: TheTruthAbout…

Mr. Savvy and I are frequent travelers so I have a Delta SkyMiles branded AmEx.  In line with a number of other credit card providers, AmEx has decided to change the terms of my card.  The annual fee will increase as well as the foreign currency conversion fee.  In addition, there will be no more ‘always double miles’.  Needless to say, I’m not too pleased.  However, I’m weighing the pros and cons of cancelling.  The main benefit of cancelling would be no more annual fee.  However, the main drawback to cancelling would be the loss of the annual companion ticket.

While I definitely like and use the companion tickets, I’m not sure how long that will remain a viable option once the Delta/Northwest merger is complete.  If the change in baggage fees is an indication of things to come, I may have to switch my loyalty to AirTran.  Have any of you seen a change in your credit card terms lately?

photo credit: Mike Licht, NotionsCapital.com

Yeah, the economy is bad right now.  It’s been on the news for months and most everyone is feeling it, either in their pockets or investment accounts.  So here are a few tips on what NOT to do in this sluggish economy.

• Live off your credit cards – It’s really essential now to put the cards away.  Your focus should be on establishing cash reserves and reducing any existing debt.  Take your credit cards out of your wallet so  you won’t be tempted.  If necessary, freeze them in a bowl of water in the freezer.
• Raid your retirement – Withdrawing retirement funds is a permanent fix to a temporary situation.  In addition to pay penalties and taxes, you will miss out on years of compounding.  That $10K you withdraw today could have been as much as $100K at retirement.
• Tapping your home equity – Even if someone will give you a home equity loan in this market, it’s still a bad idea.  There’s no indication the decline in housing prices will stop anytime soon and you don’t want to be stuck owing more than your house is worth.

Have you changed your spending or investing habits in this economy?

How often do you seriously and completely review your finances? I would suggest no less than once and year. You may discover ways to save money or ways that you’re just plain wasting money. After our state of the union, I will post the decisions/changes we make. I invite you to do the same.

1. Your credit score is below 600 – If this is the case, the first step is to pull a copy of all three of your credit reports.  If you have accounts in collections, you need to resolve that first.  Many creditors will allow you to go on a payment plan.  However, you MUST pay them according to that plan.  Don’t make promises you can’t keep.  Next, bring any past due bills current.  Those two things will have the greatest impact on your credit score.  After that, only time will improve your score as the negative items fall off.
2. You are saving less than 5% – I recommend saving 10% for retirement as the bare minimum.  You also need to have an emergency fund of at least three months’ expenses.  If that’s not possible at this time, establish a mini-fund of $1000.  That amount will allow you to stop using credit to cover unplanned expenses.
3. Your credit card balances are rising – If this is happening, you are spending more than you make and it needs to stop NOW.  Take a long, hard look at your spending and see where you can cut expenses.  Reduce your cable package, lower your cell phone bill, stop buying clothes, stop eating out, etc. until you take control of your debt.  The first step is getting out of a hole is to stop digging.
4. More than 28% of your income goes to your house – This issue is not as easy to resolve but it still needs to be considered.  First consider increasing your income.  Then consider decreasing your housing costs.  If you’re not renting, that may be hard but you need to evaluate what steps you’re willing to take to improve your financial situation.  The economy will probably get worse before it gets better so why live on the financial edge if you don’t have to?
5. Your bills are spiraling out of control – Lay out all your bills and start cutting things.  Eliminate the fancy cable, the home phone, any non-essentials.  Get a roommate (if possible) if you have to.  Extreme times call for extreme measures.

photo credit: »Philo

Consumer Reports published an article on the eight benchmarks of borrowing.  I must say that I don’t agree with all of their benchmarks.  For example, they state that non-mortgage debt (i.e. auto loans, credit cards, etc.) shouldn’t be more than 20% of your gross income.  If a person has a gross income of $45K (close to the US median), that’s $750/mo.  That’s definitely a bit bunch and an indicator that you’re probably living above your means.

The article also lists 28% for mortgage payments (PITI) which I feel is reasonable.  However if you’re spending 20% on non-mortgage debt, 28% on your mortgage, 25% on income tax, you can see where this is headed.  Not much left to pay other bills or save.

Last but not least, they give a benchmark of 650-700 for your FICO.  I consider 650 average at best.  700 is a much better bar to set.  Once you reach that level, you’ll be able to obtain the best rates for loans and credit cards (though I hope you won’t carry a balance).

How do you compare to Consumer Reports’ benchmarks?

What can I say – I’m a nerd. From an early age, I loved all things math and money. Even now, I think spreadsheets are fun. As a result of my interest (and maturity for my age), my parents opened up their finances to me (which was a big binder with sheets showing all the income, bills, etc.) and started teaching me. They didn’t hold anything back and openly and honestly answered any and all questions I had. I know they never did that with my brothers to the extent that they did with me. Perhaps because they didn’t show an interest or maybe couldn’t be trusted with all that information.

Once I reached 8 or 9, they would actually let me pay all the bills (they’d just sign the checks) and balance their checkbooks. I had a passbook savings account where I had to put part of my allowance and any gifts I received. So the stage was set as a child. That’s not to say I didn’t ever stray though.

My freshman year of college, I had an excess of scholarship money plus spending money from my parents. Needless to say, I was living pretty high on the hog. (Just as an example, I spent spring break in Jamaica that year.) Then I lost my scholarship (too much living it up and not enough studying it up). So when my parents had to pay that high private school tuition on their own, the spending money dwindled. I’d already had a taste of the “good life” and wasn’t ready to give it up so I got a credit card. I would run it up each school year (always paying the minimums though) and pay it off with the money from my summer job. Rinse lather repeat all the way through grad school. The summer after grad school I paid off my credit cards again (for what I thought was the final time) then moved to California.

The cost of living was ridiculous there (especially compared to my hometown in Alabama). The rent for my one bedroom apartment in a far suburb of San Francisco was more than my parents’ mortgage. Of course I needed furniture for my new apartment, my car insurance tripled and I was partying every weekend (gotta make friends you know). So practically from the start, I was living check to check and running up my credit cards. I got laid off from my job after eleven months. This was in October. I remember that I only had enough money to make November bills and NOT December rent and didn’t even have enough money to get myself home if need be. That was the worst feeling in the world. I was blessed to be able to find a job in time to make December rent and I vowed that I would NEVER live like that again. I had never really stressed about my finances before but that was the wakeup call that the way I was living wasn’t (financially) right. I shared with my dad (before then, my parents had little insight as to my finances) and he told me about the Motley Fool (www.fool.com) and started teaching me even more. I started changing my spendthrift ways (I used to shop EVERYDAY during lunch – gotta love working near Union Square) and starting seriously tithing (vs when I felt I could afford it). After that, things only got better. I started living WITHIN my means (which wasn’t always easy) and started writing down my goals. I didn’t accomplish all of them in the time frame that I wanted but when I look back at my old journals, I have accomplished and exceeded every single (financial) goal I set for myself. That’s not to say I didn’t face any other hardships (for example, getting laid off again after four months) but once the stage was set, I was able to weather the future storms.

So what’s YOUR personal finance story?