Paying Off Your Credit Card Each Month Can Boost Your Credit Worthiness

It should be common sense that people who pay off their credit card balances each month are better credit risks that those who carry a balance, but that has not been reflected in traditional credit scoring.  Current formulas for calculating FICO scores do not distinguish between those who pay off their credit card balances each month and those who make timely payments but continue to carry a balance.  That may be changing soon due to the introduction of “trended credit data” which separates “transactors”, those who pay off their credit card balances each month, from “revolvers”, those who carry a balance on their credit cards.

The three major credit reporting companies, Equifax, Experian, and TransUnion began using trended credit data a few years ago and have found that differences in payment patterns can predict the likelihood of default.  A study by TransUnion discovered that revolvers defaulted three times more often than transactors on new credit cards and auto loans and five times more often on current credit cards.  The credit reporting companies are making this trended credit data available to lenders who are using it to determine credit worthiness, not only with regard to the extension of credit but to the types of credit offered and rates of interest charged.

Transactors are considered low-risk and when this is combined with other alternative non-credit data (checking accounts, address changes, and magazine subscriptions) it can boost a person who is considered to have a “non-prime” credit status using traditional credit scoring to “near prime” or “prime”.   Such an increase in a person’s credit rating has a huge, positive impact on the availability and cost of credit.

The major credit reporting companies now offer credit evaluation products that include not only trend credit data but alternative non-credit data, as well.  Experts in the field say it is only a matter of time before FICO scores reflect these additional factors.  At last, in addition to keeping your finances in order, paying off your credit card balance in full each month will garner the additional credit worthiness you deserve.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based LifestyleDouble-Dome Publications, 224 pages

Standard of Living Too High for Majority of Americans

The diagnosis of financial planning professionals is that Americans aren’t saving enough:  we are not putting enough money into our regular, short-term savings nor are we funding our retirement savings adequately.  This view is supported by numerous surveys that reveal a majority of Americans fall far short when it comes to adequate short-term savings and retirement savings.

What does “not saving enough” really mean?  It means that a majority of Americans spend too much.  Otherwise, they would have the money to contribute to savings.  Their standard of living is simply too high to be sustainable.

Savings equals sustainability

Without enough money in short-term savings to cover unpredictable expenses such as insurance deductibles and co-pays, repairs and maintenance to vehicles and a house (if one is a homeowner), repair and replacement of appliances, and a loss or reduction of income for a minimum of three months, that standard of living cannot be sustained over the long term without borrowing from retirement funds or relatives or friends or from traditional lenders.  If a person has to borrow to maintain his standard of living, he is in over his head.  This should have been evident in the aftermath of the Great Recession that began in 2007, but apparently, the lesson has not been learned.

A lack of short-term savings puts pressure on retirement savings.  Most Americans aren’t contributing enough to retirement accounts to maintain their current standard of living when they retire as it is.  With little or no short-term savings, retirement accounts become emergency funds that are plundered to cover unpredictable expenses when they arise.  Every time there is an interruption in income or an insurance deductible is to be paid or there is a major repair needed to a vehicle or the house, retirement funds take a hit.

Not retiring is a false option for most people; they will retire whether they can afford to or not and usually sooner than they had planned.  Social Security alone will not support them.  Retirement savings are as critical to the sustainability of a standard of living as are short-term savings.

A lower standard of living is the answer

What’s the answer?  A majority of Americans need to downsize their standard of living to a point where they can put at least 10% of their take-home pay into short-term savings and contribute an additional 10% to 15% to dedicated retirement accounts (401k, IRA’s, etc.).  At that level of saving, they will enjoy a sustainable standard of living, one that can withstand unpredictable expenses without resorting to a raid on retirement savings or borrowing and which can be supported in retirement.

Downsizing suggestions

Where to start to downsize?  Prioritize spending and make saving the number one priority.  Create a budget that reflects your spending priorities and live within it.  Eliminate convenience; invest more of your own labor.  Buy on sale and stock up.  Downsize housing; 40 years ago, American’s used to live comfortably in houses that were 1200 sq ft..  Drive new vehicles longer or buy used.  Maintain what is owned to get the most value out of it.  Resist the temptation to upgrade housing, appliances, electronics, and vehicles.  Save increases in pay, income tax withholding refunds, bonuses, and other windfalls.  Shift from consuming to saving.  Look for happiness and satisfaction in the non-material:  relationships with family and friends, service to others, the satisfaction of doing a task to the best of your ability, and the beauty and wonder of nature.

Our standards of living are comprised of many superfluous and expensive goods and services that we don’t need in order to be contented but which give us some form of immediate gratification.  We can cut these out and still live full and satisfying lives with financial security and money enough to pay for those things that are most important to us at a standard of living that is sustainable.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based LifestyleDouble-Dome Publications, 224 pages

Three Questions That Indicate Your Financial Literacy

To successfully accumulate retirement savings and then make that money last throughout retirement, a person needs to have some basic financial knowledge. The Wharton School Pension Research Council at the University of Pennsylvania developed a three question financial literacy test to determine the level of financial literacy in various populations.

A short financial literacy test

Here are the three financial literacy questions that comprise the test:

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

a. More than $102
b. Exactly $102
c. Less than $102

2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, how much would you be able to buy with the money in this account?

a. More than today
b. Exactly the same
c. Less than today

3. Please tell me whether this statement is true or false. “Buying a single company’s stock usually provides a safer return than a stock mutual fund.”

a. True
b. False

Information to answer test questions is basic and readily available

How did you do? (The correct answers are at the end of this post.) I suspect you probably scored 100%. Why? Because if you found this blog, you must have an interest in personal financial matters; that interest motivates you expand your knowledge of the subject. The information necessary to correctly answer the three questions, the affect of compound interest on savings, the impact of inflation on purchasing power, and the need to diversify investments, is readily available to anyone with the slightest interest in personal finance. You, no doubt, encountered this basic information early in your education on personal finance matters.

Test results in United States

With so much information available on personal finance, specifically retirement saving and investing, it is surprising that Americans over 50, who should have an interest in this subject, scored so poorly when given the test:  only 50% answered the first two questions correctly and only 33% answered all three questions correctly. When the test was give to a more comprehensive sample representing all Americans, the results were essentially the same. Participants with more education fared better on the test, but still the scores were disappointing: 64% of those with a post-graduate degree answered all of the questions correctly, followed by 44% of college graduates, 31% of those with some college, and 19% of high school graduates.

Lack of financial literacy is symptom of deeper problem

The results prove the need for some kind of universal basic financial education, but the problem runs deeper than a lack of financial literacy: most Americans simply aren’t interested in managing their finances. Oh, they would like to have the fruits of effective money management; they just aren’t interested in the details. Most would much rather consume. And we Americans are expert consumers. We’re so good at it that we spend more than we earn. When it comes down to a choice between consumption or saving, immediate vs deferred gratification, most Americans want it now. Until that changes, a majority of Americans will continue to be financially illiterate—all the way to the poorhouse.

Answers: 1. a, 2. c, 3. b

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based LifestyleDouble-Dome Publications, 224 pages