Rolling, rolling, rolling… How to do a 401(k) rollover

Posted on February 28, 2014 by

A few blog posts ago I spoke about retirement with a brief conversation about rollovers.  I wanted rollovers to have it’s own, more in depth, conversation.  You can rollover your employer account for two reasons, (1) You leave your job OR (2) You reach the age to withdraw without penalty (59 ½) and you are still working.  For the purposes of today’s blog post, let’s combine these circumstances and call them a “rollable” event.

When a “rollable” event occurs, you have three options: (1) Stay in your plan; (2) Cash out; or (3) Roll your account over. Let’s talk about the first two circumstances. If you have over $5,000 (each plan’s amount might vary slightly) in your 401(k) after separation from your employer, you have the option to stay in your plan.  Under $5,000 but over $1,000, your employer can roll your money into an IRA to avoid the administration costs of keeping such a small about in the company’s plan. Under $1,000, your former employer can legally “force you out” if you don’t make other arrangements for the money in your plan.  A force out is when your employer sends you a check for what’s in your account minus the mandatory 20% withholding.

Since we are on the subject of receiving checks from your 401(k), let’s discuss the cash out option. The cash out option is when you decide to take your money and run.  You receive a check for whatever is in your 401(k) minus mandatory 20% tax withholding. That sounds great, who couldn’t use some extra money in their pocket? Well, I will ask you the question that my father asked me as a child whenever I was in trouble, “[Is] it worth it?” And on this occasion, it isn’t.  There’s no such thing as a free lunch. With the cash out, even though you had 20% held immediately, (1) the amount you received is calculated into your income and in most cases, you have to pay MORE taxes on that amount and (2) you are subject to a 10% early withdrawal penalty if you are under 59 ½ at tax time.  On top of that, you are shorting your retirement goals. With that being said, who has money just to give away to the government?

So what’s the best option? ROLLOVER.  Rolling your 401(k) to an Individual Retirement Account (IRA) is a great move.  It gives you a wider range of options that are often less expensive that YOU pick. However, you also have the option of rolling your old 401(k) into your new 401(k). But for today’s post, I’m just going to discuss the process of rolling over into an IRA.

1. Decide where do you want your IRA. 

(a) Bank- some people like the convenience of having all their accounts in the same place.  However, many banks only offer banking options such as CDs and savings accounts. Some banks can provide investment options through their investment arm but I do caution you that these options tend to be more expensive than an online account.

(b) Online account- if you don’t mind having your banking accounts in separate places, I prefer online options.  They tend to be cheaper. (Although if you want to move your banking relationship, many of these online investment firms have banking options.) Look around for deals (i.e. get $600 when you roll your account over) and  make sure you read the fine print!

2. Decide what kind of an IRA will it be.

You should roll your 401(k), or other qualified plan, into a qualified account, a traditional IRA. I know that Roth conversions are very    popular now. But it is easier to do a Roth conversion once your funds are in your traditional IRA. Before making that jump, I strongly suggest speaking with your tax advisor.

3.  ROLL IT! 

(Most people want to handle this ASAP after they leave a company, but it can take up to 60 days for your separation to show with your 401(k) provider)

(a) Tell your IRA provider that you intend to roll a 401(k) over. They will either give you a form or provide you with the information needed  to tell your 401(k) provider to execute the rollover

(b) Call your 401(k) provider or go to your 401(k) online, most providers allow you to verbally request a rollover, and  handful of providers will send your check directly to your IRA company. If they don’t, and send the check to you, just forward the check with the proper paperwork to your IRA.

Note: The general rule in rollover land is this, “As long as you don’t get the money in your hands, then it is not taxable.” So most people get upset when they have a check in their hands from their 401(k). But with a rollover the check should read, “ (Your IRA Company) FBO (Your name).” The real question is, can you take the IRA check and deposit into your bank account. With a FBO, “for benefit of,” check, you cannot because the check is written to the IRA company for your benefit.

            My money’s rolled over. What should I do next? Invest! 

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Insurance- how to make it work for you

Posted on February 21, 2014 by

            Insurance. It’s one of the few products that we understand and why we need it. Whether it’s car insurance, health insurance, or life insurance, its purpose is to protect against your loss and transfer your personal risk to a large company.  That definition sounds good, but few know what “loss protection and risk transfer” actually means in real life terms.  Ironically, many insurance sales agents do not understand what “loss protection and risk transfer” means, and the result is insurance “solutions” that do not really solve anything and are extremely expensive.  Think of it this way. You enter a car dealership with the intent to purchase a used car and you leave with a Bentley.  How’s that for a poor fit?

When I started as a financial advisor, I quickly learned what products paid the most in terms of commissions. Insurance was, and still is, number one. Some people like to sell the dream that insurance can increase wealth and protect against risk at the same time. No. Very few financial products can serve two roles equally, and insurance is not an exception.

 Here’s an example. For Ann, a 30-year old female with excellent health in Pennsylvania, purchases a $500,0000 term life insurance policy for 30 years. It would cost her approximately $335.00 per year.  However, a $500,000 whole life insurance policy would cost Ann $3,345.00 per year. At age 65, if she decided to stop paying premiums, she could either (1) cash out, terminate the policy and take the cash value of the policy, and have approximately $174,700 or (2) use the guaranteed paid up option, inform the company that she wants to stop paying premiums, take what has accumulated as a death benefit, and have an insurance policy that would pay out $397,500.00 at her death to her designated beneficiaries.

Let’s put perspective on this example. If you put, $3,345 in a cookie jar for 30 years, you would have a savings of $100,350.00. With the above example, the whole life policy would have an increase of $74, 350 over principal, which is no a small amount. However, if you put $278.75 per month, which is $3,345.00 annually, into an investment yielding 8% over 30 years (compounding the interest once a  year), you would have approximately $378,932.34. If you notice, this number is close to the guaranteed paid up option and not the cash value, the money Ann would have in hand, if she took the cash out at 65.

Where do you start? In the above example, I used term life insurance and whole life insurance. But what are they, and what is the difference between them? 

       Term. Term life insurance pays the face value, or the death benefit, of the life insurance policy if the insured dies during a specified period of time. As long as premiums, your cost of the insurance, is paid.  From the above example, the $500,000 policy amount, is the death benefit, and the specified term is 30 years. The benefit of term insurance is that it is low cost; but the drawback is that it is not permanent at the age of 60. This individual would no longer have the protection of this policy.

        Whole. Whole life is a type of permanent insurance. It provides lifetime protection, which you pay a predetermined and level premium. The cash value usually has a minimum guaranteed rate of interest, and the death benefit is a fixed amount. Most whole life policies allow you to take loans from the cash value. Whole life insurance is the most expensive life-insurance product available for its permanency, level premiums, the building of cash value, and the ability to take loans from the cash value.

           So what to do?

 The point of insurance is to transfer the risk of the loss of your earning potential, as a result of your death, from your family to a big insurance company.   Insurance is not meant to build wealth for your family; and by doing so, as seen above, it can be a costly proposition.

 Ideally, if you have minor children and a mortgage, term life insurance in the proper amount would work well.  Consider what it would take to pay off the house and make sure the children are taken care of. You could, as in Ann’s case, take the other thousands of dollars and invest it, or use it to pay off debt. And consider this, if for some time, you cannot afford your premiums, your policy will be cancelled.

I even appreciate whole life policies in small amounts, i.e. $25,000, to cover your burial and related expenses. I do caution against using insurance for wealth building when there are other, more appropriate tools to do that.

I’ve said this before and I will say it again. Not everyone may need a life insurance policy, but EVERYONE needs a will. But if you are wondering if you need life insurance, ask yourself this question, “Would my death cause a financial hardship for anyone?” If the answer is yes, then you need to get moving on finding a policy that works for you and your loved ones.

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What are these things called Mutual Funds, really?

Posted on February 10, 2014 by

           When it comes to investing, so many people hear, “You should invest in mutual funds.” And with out question, most people do. So many people invest in mutual funds that, today, nearly half of American households own mutual funds. This number is staggering considering that the number of households owning mutual funds was 6% in 1980. The increase is due to the increased availability and participation in retirement accounts, where mutual funds are the primary, and usually only, investment option.

            With so many individuals investing in mutual funds, it should be surprising that very few mutual fund owners actually know how they work.  But it isn’t, because the working of mutual funds are clear as mud. Over the next few blog posts, I hope to unmuddy the waters.

What is a mutual fund?

Let’s begin with the definition of a mutual fund. Investor.gov defines mutual funds as “a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt.”  The type of security that the mutual fund invests in depends on the objective of the fund. (We will discuss fund types in another post.) Each mutual fund has a ticker symbol. A ticker symbol is a unique five letter abbreviation used to identify mutual funds on the stock market. When purchasing a mutual fund, it is common to use the fund’s ticker symbol instead of its proper name.

The value of a mutual fund is determined by the value of the stocks at the end each trading day minus the liabilities or the expenses of the fund including management fees, the cost of keeping the “lights” on, etc. This value is called the Net Asset Value commonly called, “NAV.” The NAV is the amount that is quoted for the price of the Mutual Fund.  Note that since NAV is calculated at the end of the trading day, it is the prior day’s information.

For a simple illustration of how mutual funds work, I created my own fictional mutual fund. Since I love to shop, I have created a fake retail mutual fund called, TheIvyInvestor’s Retail Fund (ticker: IIRVX). It has three stocks for simplicity; but note, most mutual funds have hundreds of stocks.

 IIRVX opened on February 7, 2013 with 1000 shares outstanding.

Stock Symbol Company Share Price (as of 2/7/2013) Number of shares Value
JWN Nordstrom $54.91 100 $5,491.00
KORS Michael Kors $56.66 100 $5,666.00
M Macy’s $54.91 100 $5,491.00
$16,648.00

As you can see, the average investor cannot afford to purchase 100 shares of these stocks, let alone this full portfolio, a group of holdings —i.e. stocks or bonds— in a mutual fund.  To get a piece of the “action,” you can buy a share of IIRVX for $22.23. This $22.23 will not purchase individual shares of Macy’s, Michael Kors, or Nordstrom directly; but it will allow you to participate in these companies’ growth by owning shares of the mutual fund which holds them.

 How was the share price of IIRVX calculated on February 7, 2013?

 The NAV is calculated:

$16,648.00 (value of the securities at the end of the trading day)

- $2,500(liabilities)

$14, 148.00

$14, 148.00/1000 IIRVX shareholders = $14.15 NAV.

 IIRVX’s value on  February 7, 2014 with 1100 shares outstanding.

Stock Symbol Company Share Price (as of 2/7/2014) Number of shares Value
JWN Nordstrom $58.79 100 $5,879.00
KORS Michael Kors $94.22 100 $9,422.00
M Macy’s $53.09 100 $5,309.00
$20,610.00

How was the share price of IIRVX calculated on February 7, 2014?

The NAV is calculated:

$20,610.00 (value of the securities at the end of the trading day)

- $2,500(liabilities)

$18,110.00

$18,110.00/1100 IIRVX shareholders = $16.46 NAV.

As you can see, NAV changes day-to-day depending on: (1) the prices of the stocks that the fund holds, and (2) the number of shareholders.

This week’s blog posts will be a series on mutual funds. The next few posts will cover:

1. How do you make money in a mutual fund and Tax consequences

2. An in-depth look into mutual fund fees

3. Types of mutual funds available

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How would your family know your wishes if you were no longer around?

Posted on February 4, 2014 by

The topic of this week’s blog post is not fun. But I can assure you that it’s even less fun dealing with the emotions of a major family crisis and then adding the stress of not knowing how to begin piecing a loved one’s life together in their absence. If you organize your financial information and provide instructions for loved ones now, it can save a lot of time, frustration, and money for them later.

            “But of that day and hour knoweth no man…” Matthew 24:36 KJV.  Because of this, it is so important that in the case of death, your loved ones, or responsible friends, know where your information is, how to access it, and what your wishes are.

1. What are your wishes?

           The only way for your wishes to be known after death is through a will.  Without a will, any assets upon your death will be distributed through the intestacy laws of the state. (Testate means dying with a will and intestate means dying without a will. The person who makes a will is known as a “testator.”) Allowing your assets to go intestate, without a will, tends to cause a lot of confusion and family in-fighting. As a result, it is usually advisable to have a will.

A will is a document which transfers your property at your death to designated people. It can be changed until your death and is only effective upon your death.

Wills are governed by state law. Most people go to an attorney to have a will drafted, which is by far the best way. However, in a pinch, it might be better to have something rather than nothing. Luckily, half of the states allow a will written completely in the handwriting of the testator otherwise known as a holographic will. See if your state is one of them, here.

            A holographic will allows some of the formalities of a formal will to be waived, i.e. the requirements of having witnesses. It should be noted that having the will completely in your handwriting is important. With the advent of online legal websites, there has been a lot of debate regarding typed wills and in at least one case, a typed will was held not to be valid. In writing a will, you must declare it to be your “Last Will and Testament.” It must be in your writing and signed by you. You should also name a personal representative, who is known as an “Executor.” The executor is the individual in charge of carrying out the terms and conditions of your will.

2. Where is your information?

I am a huge fan of investing in a Safe Deposit Box. Safe Deposit Boxes are available at most banks for a nominal yearly fee. It can help secure important personal documents and collectibles. How do you decide what to put in the box? Use this thought as your guide: If I lost this document, it would be impossible, costly, or very difficult to replace.

One thing that shouldn’t go into your safe deposit box, believe it or not, is your will. Many states have rules about who and how a safe deposit box can be accessed after one’s death. The worst case is that your loved one would have to go to court to have the safe deposit box opened which can be costly and time consuming.

A good place for your will is in a fire-proof safe in your home or other safe place; however, wherever you place your will for safe keeping, you need to let your Executor know.

Additionally, you should have a list of information available either in your possession where a trusted family member or friend knows how to find it, or better yet, with a trusted third party, such as an attorney or accountant.  I have provided a good starting point for you to use to begin your information collection process, PersonalInventory. Please note that each section is not exhaustive, some sections may apply to you and you may need to add others as you see fit. For example, many people like to have a listing of important property such as a watch or coin collection or a listing of firearms.

3. How would a loved one access your information in your absence?

Let a family member, or trusted friend, know how and where to find your information. For example, tell them  “my safe deposit key is in my top drawer in a blue envelope” or “my safe is in the basement and the code is my wedding date.”

With all the formalities of a will and the different requirements of each state, it is probably the best and safest bet to have an attorney draft a will for you. Many states have law schools with legal clinics with law students willing and able to help you for no fee.

Final Thoughts

I will discuss some of these topics in more detail in the future. I wanted to provide a primer to get you started in getting your “house” in order. My favorite quote is with regards to these matters is, “My people will perish for a lack of knowledge.”

Today’s post provides information about the law designed to help readers cope with their own legal needs. However, this information is not the same as legal advice. Although I have gone to great lengths to ensure accurate and useful information, I do recommend that you consult a lawyer if you want professional assurance that the information provided is appropriate for your particular situation.

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Getting started with investing

Posted on January 27, 2014 by

Today’s blog will be featured in Pull Magazine’s print version.

The costliest mistakes, in life and investing, are usually fear based. Successful investing does not require a specialized degree.  It does, however, require time and a plan. Many people believe that wealth and financial freedom is unattainable unless they win the lottery. That is not true.

When I present individuals with tools to produce long-term wealth through investing, I usually hear two things: “I can’t figure that stuff out” or  “I’m afraid I’m going to lose money.” I can’t figure that stuff out usually means, I’m afraid of making a mistake. Aren’t we all?  However, if you do not invest, you WILL lose money by losing out on the opportunity to earn money. Not investing could be the costliest mistake you make.

How? In 2000, if I purchased an item for $100.00, that same item would cost $135.28 in 2013.  Inflation decreases the value of money over time and erodes its buying power. If your money is not earning at that same rate as inflation, you are losing money. You must actively do something to counteract inflation.  This also means that in order to “make” money, you need to invest in something that will exceed inflation over the long term.

There are several financial products available; however, many will not exceed inflation. Bank savings accounts, money market accounts, and Certificates of Deposit typically do not exceed the inflation rate. In order to consistently exceed inflation, you must look to the stock market. Overall, the United States stock market has had positive returns during any 20 year period since the 1920s.  Considering that time period included the Great Depression, the stock market should not seem as scary over the long term.

Five Rules for investing

1. Stocks are risky.

The best way to guard against risk is time. In the short term, there can be jaw dropping, blood pressure rising, catrospic swings     in the market.  That’s why rule #2 is so important.

2. Patience is paramount.

  Investors who use a buy and hold strategy for 10 years or more, do well. Warren Buffet, the owner of Berkshire Hathaway and the world’s greatest investor said it best,  “If you don’t feel comfortable owning something for 10 years, then don’t own it for 10 minutes.”

3.  Educate yourself.

Do not invest in a business that you cannot understand. The great thing is, we know more about businesses than we think we do. Look at your habits. Where do you do your grocery shop? Where do you buy gas? Where do you buy your morning cup of coffee?  Do you drink Pepsi or coke? We tend to be ardent supporters of certain brands. Why don’t you own a piece of them? Google is a highly useful tool to use when getting more information about companies.

4.  Use index mutual funds. Here is a great piece about finding good index funds from one of my favorite guides to personal finance, Kiplinger’s.

In most years, many standard mutual funds do not beat the market. As a result, an investment strategy that works well is buying a Standard and Poor’s (S&P) 500 index fund or a Wilshire 5000 index fund instead of paying a manager significantly more in investment fees to select what he or she believes to be the best funds.

5. Don’t overdiversify.

 When investing, many individuals spread their money too thin.  When too little money is spread over too many investments, you don’t realize many gains and it’s generally hard to evaluate how your account as a whole is doing.

Pick an index mutual fund and one or two stocks to begin investing.  If you aren’t able to reasonably purchase more than one stock, then don’t. I’m a proponent of purchasing round lots, which are 100 shares of a stock, when feasible. However, I do realize this can be hard considering the per share price of any given stock. My main point is to buy a large number of shares, as many as you can. You should feel comfortable buying a large number of shares if you follow rule numbers 2 and 3.

Investing is not hard.  It requires educating yourself and patience.  Many of the online brokerage firms such as Ameritrade, E-trade, Scottrade, Merrill Lynch, have great investment commentary available to read.  Find other people who invest and talk to them, exchange ideas. The key to investing is life long learning and patience.  If you can master those things, you will have a good time making money.

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Demystifying the Alphabet soup of Retirement

Posted on January 21, 2014 by

Retirement. Everyone wants to get there but very few know how. When individuals receive their benefit package, it often contains information about how to enroll in a retirement plan, but not much else. There are a lot of retirement options - SSI, IRA, 401(k), 403(b), IRRA, Roth IRA - but what good are options if you don’t know how to use them? This blog post is part of an ongoing series about retirement. As a random fact, the names 401(k) and 403(b) come from the section of the Internal Revenue Code that allows them.

 Ideally, retirement assets should be compromised of savings and investments, social security benefits and if available, pension benefits (defined benefit plans). Unfortunately, the overwhelming majority of companies no longer provide pension benefits for employees. As a result, if an individual does not have a substantial amount of savings available for retirement, then they are forced to rely on social security as their sole source of income.  Often, social security benefits cannot cover day-to-day living expenses forcing many individuals to work longer or never fully retire.

But for those of us who have 20 to 30 years left until retirement, we have so many options available to us to save and secure our future. Let’s use them wisely.  There are two basic retirement options available - employer sponsored plans and individual retirement accounts.

Employer Sponsored Retirement Accounts (Defined contribution plans)

The type of business your employer has, in addition to the type of work it does, generally dictates the type of employer sponsored plan available. For instance, 401(k) plans are traditionally used by for profit, larger companies; 403(b) plans are used by non-profit organizations such as schools, hospitals, and churches; 457 and Thrift Savings plans are used by government agencies. Although most employer sponsored plans share similar qualities, there are some differences.

How much can I contribute? 

For 2014, the contribution limit is $17,500.00 for employees under the age of 50. Employees over the age of 50 are given the ability to accelerate their savings with a “catch up” provision and can contribute an additional $5,500.00. Traditionally, only before tax money was contributed to employer sponsored accounts. Now, some employers offer a “Roth” option in their plans, which allow contributions after tax money. However, Roth and Traditional contributions cannot exceed the allowable amount for the year. For example, if you are under 50, you can contribute $10,000.00 before taxes and $7,500.00 after taxes during the year. For information from the IRS, click here.

Employer Match?

In plans where the employer offers a match, those matching funds may not be yours immediately. Matching funds are usually set up on a graduated vesting schedule. Vesting basically is the time table for when your will be entitled to 100% of the money your employer has contributed on your behalf. The longer you work for the company, the more of the match is yours. Full vesting can take anywhere from five to seven years.  However, all of your contributions are immediately vested.

Individual Retirement Accounts (IRAs)

Individual retirement accounts (IRAs). Overall, there are two types of IRAs, a traditional IRA and a Roth IRA. IRAs are individual accounts that can be set up through financial institutions, such as a bank or brokerage firm (e.g. E Trade, Scotttrade, etc).  A traditional IRA allows you to contribute money before taxes; the money grows tax deferred, and you pay taxes on the money once you withdraw the funds in retirement. This is true as long as the contribution rules are followed. A Roth IRA allows you to contribute after tax money and have it grow tax free. No taxes are paid when you withdraw the money in retirement.

How much can I contribute? 

In 2014, the contribution limit for IRAs for individuals under 50 is $5,500. For those individuals over the age of 50, they are allowed an additional $1,000.00. For information from the IRS, click here.

There are also income limits to consider when dealing with IRAs. For a traditional IRA, if you have an employer sponsored plan at work, the amount of the contribution that the IRS will allow you to deduct will decrease as you make more money.  With Roth IRAs there are a few snags. For example, you cannot contribute more money to an IRA than what you earned in a given year. For individuals above a certain income (IRS website), the amount you are able to contribute can be reduced or completely eliminated.

What is the difference in contributions? (Roth v. Traditional)

With Traditional accounts, both IRA and employer sponsored, contributions before taxes, grow tax deferred, and are taxed when you withdraw. The benefit of making before tax contributions is the ability to lower your taxable income now.  If you make $80,000, and contribute $15,000, your taxable income is $65,000.  The drawback of not paying taxes now is that you will have to pay them later, and you have to hope that your tax bracket is lower than what it is now.

With Roth accounts, both IRA and employer sponsored, contributions are after taxes, grow tax free, and are not taxed when you withdraw.  The benefit of making after tax contributions is that you are able to position yourself in the future with a sum of money that is tax free.  The drawback of paying taxes now is, well just that, you are paying taxes now.

I suggest AT LEAST using your employer account to get the match, if available.  There are many calculators online to determine how much pre-tax contributions will it affect your take home. Use them. The best strategy is diversifying your taxes — contribute some pre-tax money and contribute some after tax money, either to a Roth IRA or a Roth employer sponsored plan.

Rollovers

Three words. JUST DO IT! There are a few things that can happen with old employer accounts.

One, the old account can sit around unmonitored. Unmonitored accounts are not a good idea. Employer plans can change investment options at any time. Sometimes the investments you thought you had can be phased out and your money sits around in a money market mutual fund doing nothing.

Two, you could be “forced out” of the employer’s plan because you don’t have enough money to stay in. Each plan and amount is different.  This force out could get you a check in your hand.  The money in your hand is now taxable at your ordinary income tax rate; and if you are under the age of 55, you could be charged with an additional 10% penalty. It’s not worth it.

Three, this is the best option. You can ROLL the money over to your new employer account, if able, OR (my personal favorite) ROLL the money into an IRA.  Why do I love rolling money into IRAs? It’s yours!

Investment Options

In a few weeks, I will discuss investing in more detail.

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Oh the Wild, Wonderful (scary) World of Credit.

Posted on January 13, 2014 by

Albert Einstein sums up my thoughts on credit (and actually all personal finance matters) in one quote,  “You have to learn the rules of the game. And then you have to play better than anyone else.” We have to know how credit works and use it to our advantage; it’s too expensive not to. Like it or not, our credit score affects us consistently. We know that lenders access our credit report and score to extend offers of credit. But did you know collection agencies can access your credit report to collect a debt? Or insurance companies can access your credit report to provide terms of insurance? Or with your express written permission, employers can access your credit report for employment?  Or interestingly, certain social organizations are accessing credit to extend invitations of membership?

Under the Equal Credit Opportunity Act, you have the right to know why you were denied credit or offered less favorable terms than what you applied for within 60 days of the denial.  You also have the right to request a credit report based on any lender’s adverse action towards you because of your credit.

My biggest concern is that people learn about credit problems or address them too late in the game. They begin to address issues when they decide to buy a house or after they were denied credit. Unfortunately, it’s too late then. It can take up to two years to sufficiently address poor credit to put you in a position for good terms with a mortgage. Your credit determines IF you will get a loan and what cost you will pay for that loan (interest rate). Even if you can have credit extended, bad credit will cost more…  If “no credit, bad credit, no problem,” means driving around a car with a 16% interest rate, there is a BIG problem. I’ve been there, done that!

If you use the debt management program from last week’s blog, then with hard work you should be able to get on top of your financial issues and control them in the future. It’s about changing your mind about money. Although I tell people to put their credit cards away during debt management, I still believe in the use of credit. We must begin using credit as a tool, such as bonus points for flying or coupons at your favorite stores, not a crutch. I’ve had bad credit in the past, not only was it not fun, but it was VERY expensive. Knowing what credit is and how it works, should help you manage it in a way that is beneficial, not detrimental, to you.

First, What is your credit report? 

Your credit report contains your history and the current status of your accounts. Generally, it includes:

  • Payment history and the length of time you have had credit
  • How much credit you have, and of your available credit, how much of it is in use
  • Whether you have any delinquent debts.

Generally, delinquent debts such as collection accounts can stay on a credit report for 7 and a half years. Credit reports may also include judgments, liens, or bankruptcies. Depending on the type of bankruptcy filed, the bankruptcy can stay on a credit report for up to ten years.

However, usually when people talk about credit, they are actually referring to their FICO score. The word FICO stands for “Fair, Isaac and Company.” It is the number lenders use to determine whether to: (1) give you credit; and (2) if so, how much; and (3) at what cost to you (the interest rate). Scores range from 300-850. A score in the 700s is considered a “good” score. Unlike your FREE credit report, you have to purchase your FICO score.  But it can be done when you purchase your free annual credit report. However, there are a scoring models used beyond FICO, these scores may vary depending on which of the three major credit bureaus the lender is using and the scoring model they employ, if they are not using the score provided by the credit bureau.

Second, how often should you check your credit report?

As I said in last week’s post, you should check your credit report at least once a year at Annual Credit Report.com.  As a side note, if you check your credit, it is considered a “soft inquiry” and will not affect your credit score. However, a lender checking your credit score for the purpose of extending credit is considered a “hard inquiry” and will affect your credit score.

Third, what should you look for?

It is so important that you thoroughly examine each of your credit reports. You will find that each agency’s report looks different, but also that the information on the report might be different. On each of your three credit reports from Experian, Transunion, and Equifax, you should check the following things:

(1) The credit accounts reported are yours.

  • Look for loans or credit cards listed that you never opened, addresses of places where you never lived, or names of  employers you never worked for. (Any of these issues could be a sign of Identity theft)

(2) That the accounts reported are complete and accurate.

  • Look to see that your accounts are reporting correctly
  • Look for collection accounts that were not updated after a settlement was reached and satisfied. I suggest that you also look for duplicates of the same debt appearing on your report. There should only be one listing of any debt you owe.

(3) That the information reported still belongs there.

  •  Look out for old collection accounts (over 7 years), bankruptcies over 10 years, etc.

Fourth, what if you find a problem?

DISPUTE! DISPUTE! DISPUTE!

All three of the major credit bureaus allow you to dispute online.  I suggest the online method. Over the years, I have done disputes online and through USPS (United States Postal Mail), and I like the experience online better for ease and cost.  If you are disputing by mail, it is best to do certified mail so you know what date the bureau received your letter.

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