A Squeaky Clean Credit Report

Question of the week:It seemed that every place I did my holiday shopping this year offered a discount for opening up a store credit card. I'm afraid that I fell for it and now find myself the holder of four brand new credit cards. Have I ruined my credit score? --J.T., Gainesville

Dear J.T.,

Owning a handful of cards seems to be a habit for most Americans. According to Fair Isaac Corporation (FICO), the company that compiles credit scores for the three national credit reporting agencies, the average consumer has about seven credit cards. I suspect that some of those accounts were opened under circumstances just like yours.

When we asked Armchair Millionaires about the number of credit cards they have, we heard the entire gamut, from those who believe in keeping credit cards to an absolute minimum to those who have a whole stack of plastic. Here are two such comments:

"I have just one credit card which I use daily for everything. I chose it because I receive frequent flyer miles for each dollar I spend. Without fail, I pay the entire balance monthly." --Cecelia KC

"I have 16 credit cards, although I only really need one. All of these cards are older cards that I'm trying to pay off and then close." --Jenny

In terms of how your new cards will affect your credit score, you can take comfort in knowing that, according to FICO, the amount of new credit you have is just one of many factors it considers when it calculates your score. My guide provides an overview of the information FICO uses to determine your score, along with tips for improving your score.

The Armchair Millionaire's Guide to Ramping Up Your Credit Score

• Payment history. Whether or not you've been late paying your bills is the most important factor FICO looks at in calculating your score. Raising your score in this area is simple: Pay your bills on time!
• Amounts owed. This includes how much you owe overall, how many accounts have balances and how much of your credit line you're using with each credit card. The best way to improve in this area is to keep your balances low or better yet, at zero.
• Length of credit history. This looks at how long your credit accounts have been opened and how long since you've used certain accounts. In general, a longer credit history will help your score. On the other hand, opening a lot of new accounts all at once will lower the average age of your accounts, which will have a negative effect.
• New credit. This includes how many new accounts you have, how long it's been since you opened an account, and how long it's been since lenders made inquiries on your credit report. To keep your score up in this, don't open up a lot of new accounts all at once. At the same time, if you've had credit problems in the past, you shouldn't hesitate to open a few new accounts over time--provided you know you'll be able to pay them off in time.
• Types of credit you use. FICO looks at the kinds of credit you use, such as credit cards, a mortgage and car loan, as well as the total number of accounts you have. In general, having a mix of accounts will improve your score--people with no credit cards, for example, tend to be a higher risk than people who have credit cards and manage them well--but you should still not open new accounts just to get a better mix.

THE BOTTOM LINE: Because your credit score is determined by so many different factors, one wrong turn is not likely to completely sink your score. The accumulation of many bad decisions will, however. Know what keeps your credit score up and manage your credit accordingly.

Knowing Your Score

Question of the week:I've heard that it's important to check your credit score, but I've no idea of how to go about this, or if it's even worth it. What are your thoughts? --Marti O.

Dear Marti,

Ah, the elusive credit score. This seems to be one of the most mysterious--and misunderstood--issues in personal finance. But it's certainly an important part of your overall financial picture, and one that it really pays to understand.

When we asked members of the Armchair Millionaire community about whether they make it a habit to check their credit scores, we found that many do. Here are two of the comments we heard:

Prevent surprises. "I regularly (once per year) check my credit score, along with my credit report. I don't want any surprises when I need to get a loan." --Bryan J.

Make a resolution. "I check mine once a year when I check my credit reports for identity theft problems. I made it a New Year's resolution to improve my credit score last year, and it worked. I was able to raise it a bit." --Andy

In a nutshell, a credit score is simply a number that helps lenders know your credit risk. In other words, it tells them how likely you are to pay back your loan in time. While lenders may make their decisions to extend you credit based on many different factors and credit scoring models, the one credit score used by most lenders by far is the FICO score (so named because it is developed by Fair, Isaac and Company). This score is based on information on your credit report and is provided to lenders by the three big credit bureaus: TransUnion, Experian and Equifax.

While that's simple enough, it's made more confusing by the fact that you don't have a single credit score. Because each credit bureau may have slightly different information about you, and may treat that information slightly differently, your score will likely be a little different at each bureau. And because your financial situation changes all the time, so do your credit scores.

The Armchair Millionaire Guide to Credit Scoring

• Why they matter. The better your credit scores, the lower the interest rates you'll be offered. For example, according to FICO, a high credit score could mean that you're offered a 30-year mortgage at 6.3 percent. With a low score, you'd be offered a much higher rate--9.4 percent. On a $150,000 mortgage, this translates into big bucks. With the higher credit score, you would save more than $300 on your monthly payments.
• How they're formulated. FICO evaluates five primary issues in creating your credit score. Your payment history carries the most weight (35 percent), followed by the amount you owe (30 percent), the length of your credit history (15 percent) and the type of credit you're using and how much new credit you've opened recently (10 percent each).
• How to get them. Your credit scores are generally not given out as part of a regular credit report. However, you can obtain it from www.myfico.com along with your credit report, as well as online from each of the three credit bureaus. You may have to pay a few dollars extra to have your score included along with your credit report.
• How to improve them. The better you manage your debt, the better your credit score will be. Pay your bills on time, keep your credit card balances low and don't open unneeded credit accounts. If you've had problems in the past, it's especially important to get current and keep current with your loan payments.

THE BOTTOM LINE: While keeping tabs on your credit scores may seem an afterthought, remember that people with a better credit score are offered lower rates when borrowing. That could make a big difference in your monthly spending. When it comes to financial planning, little things can add up to a lot.

Keeping Your Good Name from Going Bad

Question of the week:My sister was the victim of identity theft and went through months of hassle getting everything straightened out. What are your suggestions for safeguarding your identity? --Ramona

Dear Ramona,

Identity theft--whenever someone uses your personal information such as Social Security, credit card or driver's license numbers to make purchases or open accounts--is definitely on the rise. While it's impossible to put exact numbers on it, a report last year by the General Accounting Office said that up to 750,000 Americans are victims of identity theft each year.

There's certainly plenty of anecdotal evidence within the Armchair Millionaire community. When we asked members about identity theft, we heard from several people who had been victimized. This story was typical:

Mysterious credit card user. "I had credit cards that I had not used for some time suddenly appear with balances. I canceled the cards and was not penalized and also asked the credit bureaus to put a fraud alert on my Social Security number. I am also checking my charges on the Internet almost daily as this will probably happen again." --Steve

As your sister experienced, the hardest thing about having your identity stolen is clearing out the illegal activities from your credit report. It's certainly far easier to keep it from happening in the first place. My guide provides the steps everyone should take to protect their identity.

The Armchair Millionaire Guide to Preventing Identity Theft

• Careful with your checks. Never have your Social Security or driver's license numbers printed on your checks. Put your work phone number instead of your home number on your checks. If you have a P.O. box, use that instead of your home address.
• Careful with your credit cards. When you pay your credit card bills, don't write your full account number on your checks, but just the last four digits. This prevents everyone who has access to your check as it is processed from capturing your account number. When you get a new credit card in the mail, sign it immediately. And when you mail your credit card bill payments, put them into a U.S. Postal Service collection box--don't leave them in your home mail box for your letter carrier to pick up.
• Careful with what's in your wallet. Minimize the amount of ID and credit cards that you carry to what you actually need. If you have credit cards you never use, leave them at home. (Or better yet, cancel the accounts.) Don't carry your Social Security card or birth certificate except when absolutely necessary. Memorize your credit card and ATM card PIN numbers--absolutely never carry that information around with you.
• Careful with the Internet. Don't transmit credit card numbers or account information to any Web site that does not offer a secure data transaction. Look for an icon of a lock in at the bottom of your browser, or for the URL of the page at which you input your data to begin with "https." Never give out personal information unless you initiated the transaction and you trust the merchant, and never email your Social Security or credit card numbers.
• Careful with your records. Invest in a good paper shredder and use it often. Old credit card receipts and bills, bank statements you no longer need--anything with your account information on it--should go through the shredder before you toss them. Same goes for all those credit card offers you get in the mail.

THE BOTTOM LINE: With all the tools available on the Internet, you no longer need to rely solely on your financial advisor to get your questions answered. While it will never replace that human touch, it can absolutely make you a better, more-informed manager of your own money.

Making Your Plastic Pay

Question of the week:I get a half dozen credit card offers in the mail every week. I'm tempted to go with one that offers frequent flyer miles, but the annual fee is $60. How do I figure out which is really the best deal? --B. Gonzalez

Dear B.,

Given the Americans are up to their necks in credit card debt, people are smart to get as much as possible in return for all the interest they're paying. According to the Federal Reserve, revolving debt (which mainly includes credit cards) is at an all-time high--we owe a cool $725 billion, at an average interest rate of 12.9 percent.

What to do? When we asked Armchair Millionaire community members for their tricks on getting the most from their plastic, we heard some interesting stories. Here are three:

Go on vacation. "I travel regularly for business and have put over $300,000 in company-paid expenses on my Amex in the last four years. At one point for every dollar spent, the points add up! My wife and I recently spent a week at a Hilton in Hawaii. The entire vacation, including our airfare from our home, cost us nothing more than cashing in some of the points." --David

Pay for college. "I have two credit cards that give me cash back for my child's education that go into her 529 account and her Upromise account." --Shelly

Get bucks back. "I pay for all my work expenses (meals, hotels, materials, etc.) with the Discover Platinum Card, which rewards me 1 percent cash back on all my purchases. If I charge $50,000 a year for company- reimbursed expenses, I get a check for $500 every year. There's no annual fee, and I pay the balance each month so I don't pay any interest." --Josh

To understand if those frequent flyer miles are really worth the 60 bucks a year, you really have to run your own numbers. If you charge enough to get a free ticket every year or so, it could certainly be worth it. If you only earn a free ticket every ten years, however, than clearly the $600 in annual fees that you would have paid over that time would more than cancel out the value of that ticket.

But the gimmicks are not all that you should consider when looking at credit card offers. My checklist provides a complete rundown on everything you should look at to make sure you get the best deal.

The Armchair Millionaire Checklist of Credit Card Features

• The rates. This is the first thing most people look at, but remember to consider more than just the annual interest rate. Does the card offer a lower introductory rate? Or a lower rate for balance transfers? If so, how long do these rates last? And what about the interest rate for cash advances? Also, is the annual rate fixed, or will it go up and down with prevailing interest rates? Finally, what is the interest-free grace period?
• The fees. Of course, you'll want as low an annual fee as possible (or better, none at all), but consider other less obvious fees. These include late fees and fees for charging more than your credit limit.
• The extras. Cash back, frequent flyer miles, and merchant discounts are all well-known, but many cards offer a range of other benefits that may be useful to you. To name but a few, these include travel accident insurance, travel and emergency assistance, auto rental insurance, lost luggage insurance, extended warranty protection, free additional cards, annual account summaries and online account management. Remember that frills rarely come free, however.
• The hidden "gotchas." Some cards charge a fee whenever you transfer a balance to it. Most charge a fee for cash advances (up to 4 percent of the amount). And some will cancel your nice low introductory interest rate if you make a single late payment. Read the fine print carefully.

THE BOTTOM LINE: Regardless of the gimmicks you go for, you should always follow a single rule: Pay off your cards every month. Otherwise the interest you pay will outweigh all those goodies.

Making Your Plastic Pay

Question of the week:I get a half dozen credit card offers in the mail every week. I'm tempted to go with one that offers frequent flyer miles, but the annual fee is $60. How do I figure out which is really the best deal? --B. Gonzalez

Given the Americans are up to their necks in credit card debt, people are smart to get as much as possible in return for all the interest they're paying. According to the Federal Reserve, revolving debt (which mainly includes credit cards) is at an all-time high--we owe a cool $725 billion, at an average interest rate of 12.9 percent.

What to do? When we asked Armchair Millionaire community members for their tricks on getting the most from their plastic, we heard some interesting stories. Here are three:

Go on vacation. "I travel regularly for business and have put over $300,000 in company-paid expenses on my Amex in the last four years. At one point for every dollar spent, the points add up! My wife and I recently spent a week at a Hilton in Hawaii. The entire vacation, including our airfare from our home, cost us nothing more than cashing in some of the points." --David

Pay for college. "I have two credit cards that give me cash back for my child's education that go into her 529 account and her Upromise account." --Shelly

Get bucks back. "I pay for all my work expenses (meals, hotels, materials, etc.) with the Discover Platinum Card, which rewards me 1 percent cash back on all my purchases. If I charge $50,000 a year for company- reimbursed expenses, I get a check for $500 every year. There's no annual fee, and I pay the balance each month so I don't pay any interest." --Josh

To understand if those frequent flyer miles are really worth the 60 bucks a year, you really have to run your own numbers. If you charge enough to get a free ticket every year or so, it could certainly be worth it. If you only earn a free ticket every ten years, however, than clearly the $600 in annual fees that you would have paid over that time would more than cancel out the value of that ticket.

But the gimmicks are not all that you should consider when looking at credit card offers. My checklist provides a complete rundown on everything you should look at to make sure you get the best deal.

The Armchair Millionaire Checklist of Credit Card Features

• The rates. This is the first thing most people look at, but remember to consider more than just the annual interest rate. Does the card offer a lower introductory rate? Or a lower rate for balance transfers? If so, how long do these rates last? And what about the interest rate for cash advances? Also, is the annual rate fixed, or will it go up and down with prevailing interest rates? Finally, what is the interest-free grace period?
• The fees. Of course, you'll want as low an annual fee as possible (or better, none at all), but consider other less obvious fees. These include late fees and fees for charging more than your credit limit.
• The extras. Cash back, frequent flyer miles, and merchant discounts are all well-known, but many cards offer a range of other benefits that may be useful to you. To name but a few, these include travel accident insurance, travel and emergency assistance, auto rental insurance, lost luggage insurance, extended warranty protection, free additional cards, annual account summaries and online account management. Remember that frills rarely come free, however.
• The hidden "gotchas." Some cards charge a fee whenever you transfer a balance to it. Most charge a fee for cash advances (up to 4 percent of the amount). And some will cancel your nice low introductory interest rate if you make a single late payment. Read the fine print carefully.

THE BOTTOM LINE: Regardless of the gimmicks you go for, you should always follow a single rule: Pay off your cards every month. Otherwise the interest you pay will outweigh all those goodies.