FICO Changes for 2008

Fair Isaac Corporation has announced that it will be changing the FICO credit scoring model. The new model, FICO '08, will make it easier on some and harder on others. What's happening? Here are a few of the changes and how they may affect you:

• Occasional Late Payments Not Such a Big Deal - Basically, if you always pay your bill on time and once or twice the check actually does get lost in the mail, or you really thought it was due next week, you won't get hit so hard. That doesn't mean to pretend the due date is whenever you feel like it, you still have to pay your bill on time most of the time, otherwise you're not going to benefit from this little perk. The word around the water cooler is that Fair Isaac is really trying to figure out who is most likely to stop paying.
• You're Gonna Pay for Paying Late - As mentioned above, you need to pay your bills on time most of the time (really you want to be on time all of the time, but nobody's perfect). If you pay your bills late on a monthly basis, expect your score to get worse than it was before. With the onset of this new scoring model you will be penalized for constantly being late. BUT you can make it better! How? Start paying your bills early consistently. You're have to pay them sooner or later; start aiming for sooner.
• Being an Authorized Users Won't Help Your Score - There were people profiting from other people's poor credit. How? John Doe charged Jane Doe up to $1,000 to add her onto his account to improve her credit scores. Because of situations like that, authorized user accounts (where the authorized user is not legally responsible for the charges to the account) will no longer help boost credit scores. Also, it's possible that being an authorized user could actually lower your score. While it's yet to be shown, I would think that if the majority of your credit is through someone else’s credit, your score will reflect that.
• Variety is the Spice of Life (and now credit) - You know how when you use the same insurance company for your car(s), house, & life insurance they give you discount after discount? Well, the new scoring model is taking a similar approach, however instead of discounts, Fair Isaacs will use the variety of your credit to improve your credit score. Having 10 consumer credit cards isn't going to help you much (beyond potentially helping your debt to available credit ratio). What will help raise that score is having varied types of credit: your credit cards, a car loan, a mortgage...but be sure to pay your bills or having a million different types of credit won't do you any good!

Lenders across the board (from mortgages to credit cards) are more sensitive to risk right now and Fair Isaac is trying to help correct that. With other credit score models coming out, Fair Isaac wants to keep the FICO model on top of the market place. Expect to see the low scores go lower and high scores, higher. By providing lenders (those who lend you money/credit) with a more accurate credit score (through a more accurate scoring model), the lenders will loosen their clenched fists. By using & managing your credit responsibly, you demonstrate to the lenders that you pay back loans and they'll be that much more likely to give you a loan the next time you need it. If your credit is good, keep it good. If it's not so good, now is the time to start working toward making it better.

Patience is More than a Virtue

You can have anything you want, but you may have to wait for it. In this microwave culture where nothing seems to come fast enough people don't like being told to wait. Think about it though, if you can do without some of the "stuff" now there's a much better chance you can have all the stuff you want later.

People get themselves into trouble by thinking that whatever it is they want, they have to have it now. This time of year delayed gratification can be especially tricky as shopping & spending is in the air. You go out to buy a sweater for your sister and you see a pair of pants that would be perfect with that blouse in the back of your closet. Or you go to pick up a video game for your friend and you see that big, beautiful flat panel t.v. you've been craving. And look! They have a special -- no payments until June 2008! How can you not splurge on yourself? No one else is going to buy you a $1,200 t.v. and besides, you've worked so hard this year, you really deserve to treat yourself.

Well, if you have to take the store up on their delayed payment offer, you can't afford the television. By running up your credit card balance you're saying that right now you don't have enough money to pay for what you want, but by June 2008 you'll have the money. Guess what else will happen by June 2008? A new version of your t.v. will be out -- bigger & shinier with features yours doesn't have. But you're just starting to pay for the one you had to have six months earlier. Disappointed, you send the credit card company their money, while you fume because the t.v. you really want is in the store on the shelf.

Here's the thing: You actually can afford the t.v.. You can afford whatever you want. It's all a matter of choice, of choosing when to spend your money and when to save it. If you choose to spend your extra cash on new shoes, DVDs, or toys each weekend then you're choosing to afford shoes, movies, & toys. However, if you choose to hold off on smaller impulse purchases and instead put that saved money toward a larger purchase (like that t.v.) then you wouldn't have to worry about how you're really going to pay for it when the credit card bill comes.

One of my favorite purchases is my mattress. I got a discount on it and it still cost $1,500. Since I knew what I wanted and how much it cost, I worked my future mattress into my budget. By the time I went to actually buy it I had saved enough to pay cash. I doubt that if I had bought a mattress on credit I would have paid so much, but by waiting and saving I ended up with a top quality mattress that I sleep soundly on every night. Granted the quality of the mattress helps the quality of my sleep, but what really helps me sleep better is knowing that I won't be receiving a bill I can't pay for something I cannot return.

The Perfect Storm

Ah, the credit crunch and the mortgage crisis. How did it happen & who is responsible? There's a different answer from just about each person you ask. Often it depends on their position relative to the issues at hand. Are they a homeowner at risk of, or in the middle of, foreclosure? Are they a Realtor? A mortgage broker? An investor? Or maybe someone unrelated to the industry, seemingly untouched by the events of this past July. Every person involved in each "bad loan" is responsible. It's everyone's fault. Everyone got a bit greedy.

Well, it begins at the tippity top. The tippity top of the mortgage world is not necessarily the bank that you got your loan from in the first place. It's the investor who buys that loan from the bank that gave it to you initially. When you agree to the terms of your loan and sign the stack of paperwork confirming your agreement, that package may stay with that bank (like Countrywide, they're the largest holder of mortgages in the country) or it may get sold to a bank like Countrywide, or a company like Merrill Lynch. Since these investors are the ones ultimately left holding the mortgages, they decide what they're willing to buy and how much they'll buy it for. The answer to that is based on levels of risk. In fact the decision to give someone a loan or not is purely a measure of risk.

For a while there (think 2002-2007 or so) the measures of risk got virtually thrown out the window. If you could breathe & sign your name you could get a loan (okay, maybe it wasn't quite that easy, but almost!). The investors at the top basically said, "Okay, you get the loan and we'll buy it." Loan originators (all the mortgage brokers & bankers, loan officers, and retail representatives of the bank on the corner) were basically guaranteed easy money since just about anyone could get a loan. Their greed was obvious. Get more people to sign on the dotted line, make more money. But what incentive did the tippity top investors have to buy loans that were given to people who had no money to begin with?

Well let's go back to 2000-2001 at the dot com bubble burst and the onset of the real estate boom. Now, keep in mind my experience in real estate practice is limited to California's Bay Area -- one of the priciest places to live in the country. When I sold real estate during the boom I saw one house receive 63 offers and another with an asking price of $949,000 sell for $1,500,000 (that's 50% over the seller's asking price, not to mention the cost of another house altogether!). Year after year, each January we saw approximately $100,000 of value tacked on to the previous year's price of homes. Around twenty percent equity each year for just about 5 years. From the perspective of the investor, they couldn't lose! And so the big banks, the investors, bought up just about any mortgage they could get their hands on -- including subprime mortgages (those loans to borrowers with low credit scores and often little to no money of their own brought into the transaction). Why? Because even if they ended up foreclosing on the borrowers with 20% equity each year the investor could still come out ahead. The investor is not in it because they care about fuelling the American Dream of home ownership, they're in it for the American Dream of capitalism. There's the investors' greed.

Moving on to Realtors. On one hand, it's the Realtor's job to help their client buy or sell a piece of property. On the other hand, we were the ones advising our sellers to price their homes $100,000 under market value to inspire multiple offers and we were the ones advising our buyers to offer $100,000, $200,000, $500,000 (as in the example above) over the asking price -- often with no contingencies! A few times during the boom I heard, "Well if Realtors stop telling their buyers to offer such high prices the market wouldn't be so crazy." Maybe. There are a combination of factors, but ultimately the money was flowing on into the Realtor's pockets as well. Homes rarely sat on the market longer than a week or two then closed escrow within 14-30 days, that means fast money (at least for those representing the sellers). Higher sales prices meant more money since most Realtors work on commission based on the sales price of the property. Everything worked together hand in hand to create this perfect real estate storm.

Think about it, with the easily accessible money from the investors there was an influx of buyers. More buyers than homes on the market for them to buy (that would be the definition of a seller's market, by the way) means they had to compete to buy a house at all. Not only were there more buyers, but most found that all of a sudden they could qualify for and receive a loan that was larger than they thought they could get. So instead of looking at 2 bedroom, 1 bath starter homes for $650,000, they could jump right on into the 3 bedroom, 2.5 bath family home for $850,000. Yes, they may have had to get an interest only loan, or worse, a negative amortization loan to afford the monthly payments and yes, their interest rate may only stay at 4.75% for 3 years and yes, they may have padded the seller's retirement account with an extra $125,000 over their asking price but hey, they got their dream house. And there's the borrowers' greed.

With regard to the borrowers getting into bad loans and not understanding the terms of the loan they agreed to, if you don't understand what you're signing DON'T SIGN IT. I don't care if everyone tells you you're going to lose the house, trust me that you'll find another one. Stop everything, call your loan officer, mortgage broker, whoever helped you get your loan, and ask any and all questions. This is likely the biggest purchase you will make. When you sign the paperwork you are saying that you've read it, you understand it, and you agree to it. I know few, if any, people actually read all of their closing papers, but if you don't know what you're agreeing to and what it really means and you sign it anyway you have no one to blame but yourself.

Ultimately, this mortgage crisis is just a readjustment back to where we've been in the past; back to giving money to people who demonstrate that they have the ability to repay it. Doesn't that make the most sense anyway?

How have things changed? What does it take to qualify for a loan these days? I'll let you know in another post, this one's long enough.

What It's All About

It's about money. Duh. Well, okay....the truth is that this blog is about realizing your dreams and living the life you imagine. Practically speaking, it can be difficult to live your dream if you're constantly worried about how you're going to pay the bills. So we're going to approach the dream pragmatically. We're going to chip away at one of the roadblocks that stands between you & that dream of yours. Of course I realize that "the best things in life are free," but that doesn't mean you don't need money to function in this world.

You need a roof over your head, you need heat and lights, and food, don't forget about food. All of those things cost money. You work hard to earn it, but do you realize that while you're working you've already spent some, if not all, of your money? You've likely paid Uncle Sam before you even received your check. If you're in a self-employed position (like me) it could be your responsibility to set aside what you owe the IRS (and believe me, they're not to be ignored). After that you've committed to pay your rent or mortgage. The list goes on.... How much is left? What do you do with what's left? Odds are that you're not saving it.

In 2005, the average American saves -.5% of their income. NEGATIVE .5%. What does that mean? It means that we are spending more than we make. Once we've paid all those bills, we go spend the rest and then we pull out the credit card to spend a bit more. The credit card balance increases and then the bill goes up. The cycle continues: we pay more bills, have less to spend after the bills are paid, spend more on credit, and so on.

This has to change! We can't keep digging our holes deeper and expect to get out of it. So let's get to work on the financial choices we make. Let's arm ourselves with the knowledge to make smart choices.