From Good to Excellent Credit Score?

It’s done! My wife and I are now debt free, except for our mortgage. We paid off all of our credit card debt today.

The reason we kept our credit card debt around is because we had zero-percent-interest balance transfers. The reason we are paying our full balances now is because the “teaser” interest rates are expiring. One of my financial goals is to never pay interest on a credit card!  I consider paying 18% interest to be financial insanity — something to be avoided by careful planning and financial discipline.

Now begins a waiting game to see what affect eliminating our credit card balances has on our credit scores. It will probably take 2-3 weeks for our new zero balances to get reported to the credit reporting agencies.

I do weekly credit score monitoring and my estimated credit score is 752.  The credit monitoring sites I use also have credit score simulators. One predicts my score will improve to 805, the other expects no change. I suspect that my credit score will bump up to 765 or so. Either way I’m betting my wife’s credit score will continue to jump ahead of mine. The credit rating agencies and credit rating algorithms seem to just like her better for some reason… even though our credit reports are very similar.

According to some sites 740 is already an excellent credit score, while others say 750, and a handful say 770. Because I’m a bit of a perfectionist I’m trying to achieve a credit score of at least 770.

Credit and Mortgages

I went several years living in a modest house with no mortgage. It is amazing how rich you feel when you have no rent and no mortgage! My credit score went down moderately; I seems that credit scoring agencies prefer you to have a mortgage in the mix.

Then I got married, and my wife wanted a nicer house. Boom, a new bigger house and a new mortgage.  I won’t whine too much. The new house is more comfortable and easier to maintain. And the 3% interest rate on the mortgage is hard to beat.

It was an act of will to do all of the financial transactions to get “debt free.” I was was easy to procrastinate and hard to see thousands of dollars “vanish” with a few key strokes and mouse clicks. In exchange for the vanishing money is vanishing debt. The trick now is to stay “debt free.” That will be a joint effort for my wife and me.  I’m pretty sure we can do it.

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Credit Improvement Lessons

I’ve learned many things during my credit improvement journey that I would like to share.  By reading this blog post I hope that knowledge will help you on your credit improvement journey.

• For couples, the path to better credit can and should be a shared adventure
• Discussions with you partner can be challenging! (But worth it.)
• There are no quick fixes, except, perhaps for one
• It feels liberating to get reduce your debt burden

My newest learning are largely about the emotions of finance. Whether you are in a relationship or not, money, credit, debt, personal finance, and even wealth management is an emotional process.

When it comes to finance I am extremely logical, almost like a Vulcan.  My wife’s financial personality is more emotional, perhaps like a Romulan’s.  If you don’t relate to the Star Trek references, perhaps you can relate to “Men Are from Mars, Women Are from Venus.”  I’m not saying that all men are less emotional about money, or that all women are more so.  I have seen couples where the roles are reversed.

Either way, it is rare that a couple has little emotion about money.  We all have our hangups, and some are financial.

Now, if you are currently single, I can relate too.  When I was single, I had impeccable credit and finances. I was also lonely.  I went on occasional dates, and I turned off some first dates when I picked them up in my 15-year old Saturn.  I could have afforded a brand new car, but I was too young for that to be in my financial best interest.  Believe me, you are better off without someone who complains about your car being too old!

When I finally met the right woman, my finances remained impeccable, but hers were different.  I would say that about half of our fights over the years have been about money, and that ratio became higher after we got married. My number one lesson about money and love is:

Talking about money is important, listening about money is doubly so. Knowing when to talk, when to listen, and when to postpone the money conversations is critical. Patience is better than pushiness. Your partner is likely listening — it may just take them a few days to process what you are saying.

I realize this post has focused on money and relationships.  When you are single, financial strength leads to self confidence, which leads to not being single (however be choosy… pick someone kind and mostly compatible). When you are in a relationship, realize that talking about money means listening.  If you communicate with patience and honesty you will have fewer arguments and better finances!

I realize I left a teaser at the top. What is the one quick way to improve your credit score?  Simple: pay down your balances, if you can. (And avoid increasing them with dogged determination).

What’s a Good Credit Score (or Great Credit Score)?

The answer depends on for what purpose you’re hoping to use your credit score(s).  However, my short answer is:

• Good Credit: 700-739
• Great Credit: 740+

I’m basing this short answer on mortgage rates. A FICO score of 740+ should be high enough to get the best mortgage rate from virtually lender. A FICO score of 700-739 is sufficiently high to qualify for most mortgages but at likely a slightly higher rate (+1/8 %).

Your credit score is only one of several important variables that factor into a mortgage qualification decision.  Other factors include income, amount borrowed, appraised home value, and credit history details (from your credit report).

For credit cards a score of 720+ is a high enough score to qualify for all but the most selective credit cards. Credit card company each have their own proprietary risk measures that go beyond just credit score.

One thing I have learned is that if you have a big total limit from on credit card issuing bank, you will have a harder time of getting more total credit from that bank.  The issuing banks care about how much risk they are exposed to.

So, if your are trying to grow your total available credit in general it is best to do a little bit of homework as to what is the issuing bank.  If you already have 3 credit cards from Bank of America, applying for a 4th from them is probably not your best option.  Instead look for a card issued by another bank, say, US Bank, or Capital One.

Houses

I find myself in the interesting position of owning 3 residential properties:  1) Our new “dream” house, 2) Our “old” starter home, 3) our rental property.

My wife and I decided to do things differently.  Most homeowners looking to upgrade either make an offer contingent on the sale of the first home, or sell first and buy later.  I decided that was not the optimal strategy for us.  I decided it was best to buy in the upgraded segment before the higher-end markets heated up, and to sell our starter home in a seller’s market.  Part one was buying and moving in to the new house.

The strategy worked very well.  Our “old” home resides in a market where contracts are signed in days, not weeks, and multiple competing offers were becoming common.  Our plan also allowed us to stage the old house without occupying it.   We laid down fresh mulch and 12 tons of rock.  This gave the house tremendous curb appeal.  We also put days of effort into making  sure the house was “white glove” clean from floor to ceiling — even the basement.  We left some furniture and most of the artwork behind (temporarily) for staging.  The place looked spectacular inside and out.

We listed it on a Thursday night, and by Friday night we had had 13 showings and multiple offers.  Saturday morning we discussed the pros and cons of each offer, and made a decision.  We accepted the offer that was $9000 over our asking price.

Before we started the whole process we negotiated a deal with our real-estate agent.  She’d receive the standard 3% on our new home purchase, but only 2% on the old home sale.  This meant paying 5% on the sale, rather than 6%.  This saved us over $2500 in commissions.

So far we are pleased with our new home.  It appraised for more than our negotiated price.  And even though it is about 50% larger than our previous home, our first month’s utility bills are significantly cheaper than our old home built in the 1970s.  Our new home is “high-efficiency”, with a HERS Index of 60.  We anticipate saving $800 to $1000 per year on utilities.  Moreover, we obtained a 3 percent, 15-year mortgage with a negative 1.65 points, which even after 0.5 points of origination, resulted in less than $1000 of closing costs.

All the while, the rental property continues to provide monthly “dividends”.

Simple Plan to Tackle the Home Mortgage Crisis

5&7 Plan

The idea is so simple, it is surprising that no one (that I have heard about) has proposed it.  One big problem the US government faces is the enormous pile of mortgage-backed debt held by Fannie Mae and Freddie Mac.  Another problem is that many “home owners” are underwater with their mortgages.  [How can you be a home owner if you have negative equity?]  Finally, the popping of the housing bubble continues to be a drain on the US economy.

The solution I propose is making interest on mortgage-backed securities tax free for five years.  This plan would immediately drive up the value of these “toxic” assets and drive down mortgage interest rates below historic lows.  This would provide a tremendous boost to Fannie and Freddie and even the Federal Reserve.  Increased demand for tax-free MBS would spur banks to issue more mortgages under easier terms, which would help prop up home prices.  Naturally, fewer home owners would be under water.

This would also be a boon for investors, giving them access to another tax-free asset class.  The incentive of tax-free MBS would be so powerful, it would threaten to take money away from tax-free municipal bonds.  To help offset this risk, part II of my plan would make long-term capital gains on municipal bonds tax free for seven years.  Like Cain’s 9-9-9 Plan, my plan would have a numeric title, the “5&7 Plan”.  (To avoid confusion with the 5-7 Pistol, the “&” symbol is used rather than a dash.)

The long-term capital gains provision gives investors an incentive to hold municipal bonds for at least one year.  The extra two years for municipal bond gains gives investors an added incentive to hold long-maturity municipal bonds.

The 5&7 Plan would expand the tax-free bond universe and introduce the concept of tax-free interest investing to a new group of investors… the middle class.  Typically only high-income earners benefit from tax-exempt bonds because they offer lower interest rates than taxable bonds.  Because high-income taxpayers face higher marginal tax rates, tax-free municipal bonds make sense despite lower interest rates.  If the 5&7 Plan becomes law, higher-yielding MBS will become lucrative to savvy middle-class investors.

I encourage the 2012 presidential candidates to consider adopting the 5&7 Plan.  I could see Romney offering the 5&7 Plan as a way of “cleaning up Newt’s Fannie and Freddie mess.”  Similarly I could see Gingrich pitching the 5&7 Plan as a way of “fixing the Democrat’s Fannie and Freddie problems.”  Finally, I could see Obama selling the 5&7 Plan as “an innovative way to clean up America’s mortgage crisis”.

If the 5&7 Plan gets enough press, it will revitalize the mortgage debate.  It will help turn the debate towards real solutions and away from political blame games.  And, if passed, 5&7 will energize the mortgage and housing markets in explosive ways compared to the tepid response all the other failed legislation of the past 3 years.  If you like the 5&7 Plan, share this link.  If you don’t, please share why.  I will publish all non-spam replies.  Let’s get the 5&7 debate started!

Know Unknowns: Bank Balance Sheets & The Federal Reserve

I consider myself knowledgeable about many things financial: ETFs, stocks, bonds, options, the stock market, for example.  I know the difference between an income statement and a balance sheet, and can read financial statements and prospectuses as a matter of course.

I’ve had little luck deciphering bank balance sheets. Income statements yes, balance sheets no.  They tend to be very opaque, which is one obstacle.  Loans are assets while deposits (other than Federal Reserve deposits) are liabilities.  Accurately determining the quantity, quality, type, and duration of loans can be difficult if not impossible… at least to me.  Perhaps some of this info can be found in the bank’s 10K statements.  Also opaque are details of the bank’s interest rate swaps and other OTC financial contracts.

Historically, the old-style (commercial) bank followed the 3-6-3 rule:   Borrow at 3%, lend at 6%, be on the golf course at 3:00.   Such a bank would take in deposits and lend out with loans (mortgages, car loans, commercial loans).  However, banks could not lend out all the deposits; banks had to keep a fraction of the cash in reserve.  This reserve helps to avoid the “run on the bank” problem, where too many depositors ask for their money — all at the same time.

Keeping all of this spare cash at the bank (about 3-10% of assets) is cumbersome, and also encourages bank robberies.  Banks can transfer much of this physical cash to the Federal Reserve and sometimes even earn a tiny bit of interest (0% to 0.25%, “the Fed Funds Rate”) on it.  Thus the Federal Reserve serves as the bank’s bank.  The Federal Reserve System (or “The Fed”) also helps clear checks (remember those?) and move money between banks simply by moving reserve deposit balances between banks.  No need to shuttle hard currency to and fro.  Deposits are moved with a pencil, or computer transaction in the Fed’s books.

The Fed also lends out money to banks.  Banks can borrow from the Fed at 0.75% (the so-called discount rate).  This system leaves a 0.5% profit for the Fed on the difference between the Fed Funds rate and the discount rate.

Classically the Fed would try to guide the economy by moving the Fed Funds rate and discount rate.  If the Fed thought the economy was overheating (generating excessive inflation) the Fed would raise rates to “cool off the economy”.  The Fed tried to adjust the rates so as to give the economy a “soft landing”.    If the US economy got too sluggish, with high unemployment, the Fed lowered rates.  The interesting thing (no pun intended) about these rates is that they are all short-term rates.  So short-term that the Fed funds rate is sometimes called the overnight rate.

I keep saying “classically” and “historically”, is this is how things used to be done by the Fed.  What’s new, since Fed Chairman Bernanke, has been the manipulation of long-term rates with “quantitative easing” QE, and QE2.  Also new (with the cooperation of US Treasury Sec. Timothy Geithner, Congress, and President Obama) are measures such as the AIG bailout and TARP.

The Fed has shifted into uncharted territory, and in the process neglected one of its two prime mandates: price stability and low inflation.  It also seems to have overlooked the concept of real economic growth (GDP growth adjusted for inflation).  Instead the Fed seems to be fluttering in a course of wide-ranging, unprecedented, knee-jerk reactions.

Today’s Fed is not my father’s Fed, nor are today’s banks.  Today they are increasingly known unknowns.  This path is new and the ticket stub is unclear.  I don’t see a destination nor ETA, but when I look close, very close, I see a dim watermark.  Subtle, like grey on grey, I believe I see in faint yet bold letters INFLATION.

Financial Diversification Beyond Wall Street

There are many ways to diversify beyond Wall Street’s offerings:

• CDs (Certificates of Deposit)
• Bank at a Credit Union
• iBonds and/or Savings Bonds
• Residential Real Estate
• Commercial Real Estate
• Starting a Small Business
• Collectibles (gold, silver, platinum, art, vintage cars)
• DIY home improvement

Paying down debt is also an investment:

• Paying off (or paying down) credit cards
• Paying off auto loans
• Paying off student loans
• Paying down mortgage(s)

These debt-lowering options have the side benefit of improving your credit score and lead to a healthier credit report.

Additionally, there are “investments” that benefit your finances and offer other non-financial advantages.

• Education and training.  Either self-taught or formal. (including reading this blog!)  Increase your earning potential.
• Exercise, and healthy diet.  The longer and healthier you live, the greater your potential to earn and prosper.
• Strengthen your social network.  You will feel happier, more motivated, have more job networking opportunities.

Finally, there are methods to reduce and diversify your cost of living expenses:

• Learn to cook, grill, or otherwise eat at home more often.  If you are persistent you may find you are eating better, healthier, and more economically.
• If you like coffee… brew your own.  It may take time to learn what you like, but when you do you’ll love it.  Whether it is is store-ground hazelnut drip, Vietnamese coffee with Chicory and sweetened, condensed milk, French Roast, or a plethora of other choices you will benefit.
• If you love high-quality craft beer, consider brewing your own.  After the initial investment (~$200) you can brew your own for less than $4 per six-pack.  Share it with friends, and grow your social network.
• Use those DIY skills to make your house more energy-efficient by installing low-E windows, LED light bulbs, and even update weather stripping and doors.
• Grow a garden.

I have employed all of these financial ideas except commercial real estate (not counting REITs), certificates of deposit, and gardening.  My point is that it is possible to invest beyond Wall Street’s offerings.  Wall Street now offers some great investments including ETFs, and excellent brokerage companies like Vanguard, Fidelity, and Interactive Brokers (for sophisticated investors).  Finance and investing extends beyond stocks, bonds, ETFs, and Wall Street.