For the last week, there have been numerous reports of individuals who have opened Electric Orange checking accounts and after sixty days have had a credit check run on them. Here’s a typical example of such a report at Consumerism Commentary. In some cases, apparently, after this credit check, the Electric Orange account is closed. To me, at least, this is rather ominous behavior as initial descriptions of the account indicated that there would be no credit checks, so I began investigating.

First of all, from their FAQ:

Do you pull my credit if I apply for Electric Orange and the Overdraft Line of Credit?
Yes. As part of your application, ING DIRECT will obtain information about you from a consumer credit reporting agency (a “hard pull”) to confirm that you are eligible for Electric Orange.

So, indeed, the standard practice for people who sign up for an Electric Orange account is that they check your credit report with a hard pull. A “hard pull” generally means about a -5 on your credit score that lasts for about six months, then goes away. MyMoneyBlog has an extensive explanation of hard pulls versus soft pulls.

So where did the idea that ING did not pull one’s credit come from? The story that I have been able to piece together is that when ING first sent out press releases for the account, their official policy was to give everyone a $1,000 line of credit without a credit check. Most of this initial information was sent out in January 2007 and was posted on various banking sites that post press releases and such.

Sometime shortly thereafter, ING changed their policy for new accounts. I spoke to a customer service representative at ING who basically said that this change happened a few months ago, implying that it was likely in February or March 2007. The change stated that ING did have the option to run a credit check at their discretion. Now, the policy is as stated above.

Why did they make this change? I have read many, many reports of people signing up for Electric Orange, immediately “overdrafting” their checking account, and using the overdraft protection as another credit card, which was not the purpose of the account at all - it was intended as an occasional protection against overdrafts. I would strongly speculate that this behavior warranted the change in policy from ING.

What can we learn from this? First of all, know what you’re signing up for, no matter what. If you read a four month old press release on a product, sign up for it without reading the documentation, and find out that things have changed, you’ve made a bad move. Don’t rely on second-hand information ever - investigate for yourself. Blogs like these are meant to get you thinking and point you in the right direction, but you have to do the investigation yourself.

Second, you need to ask yourself if a credit check like this is an issue for you. The credit protection offered by this account is exactly what I want. I’ve overdrafted once in my life and it was due to a mathematical error - but it ended up costing me almost $100 to deal with. With Electric Orange, it wouldn’t cost me a thing other than a few cents in interest. Plus, the account balance itself earns a 4.00% APY. My credit is stellar, so I’m not bothered by the credit check, but if your credit is poor or you’re sweating every single point on your score, this could be an issue for you.

A reader recently sent in this question about her boyfriend’s credit, which seems to be on the cusp of being quite good.

My boyfriend was recently denied financing on a used upright piano because of poor credit. He actually has enough cash saved to buy it outright, but the fact that he couldn’t receive financing was a wake-up call.

Neither of us had checked our credit reports in about two years, so we both ran them through the government’s free program. His score is 611 and mine is 718. So, while I’m doing OK and already know what I need to do to get a higher score (namely just continue to pay down my credit card as quickly as possible), he’s in a trickier position. The key problem is that he’s never had a credit card and just doesn’t have much credit history; he was trying to be smart and not get caught up in credit card debt. He only has one late payment noted on his account and it’s from when he was 18 (he’s 26 now). I recommended that he open an account right away, use it to buy a few things every month, and then pay it off each month. He has a car payment and student loans which he pays on-time, but that’s about it.

Do you have any tips for improving his credit quickly? The two things he’s going to do now are: 1) Sign up for a credit card and pay it off each month; 2) Look into a couple things on the credit report that don’t seem quite right. I realize that it takes a while to build credit (I’ve had a credit card for 8 years, and it still says that one factor counting against me is a short credit history). It’s very likely that we’ll be getting married and looking to buy our own home in the next 5 years, and we want to do everything we can to set ourselves up for financial success.

First of all, his credit score is likely 611 mostly because of a lack of credit history. Most people begin to build their credit report - good or bad - during their late teens and early twenties largely with credit cards. Although he has some credit (the student loans and car payments), the lack of at least a small amount of revolving consumer debt (i.e., credit cards) has prevented him from having a higher score.

Now, about that late payment: if he made the error when he was 18 and he’s now 26, it should be very close to disappearing from his credit report, as late payments only stick around for seven years. If you pull out your full credit report (you did keep a copy, I hope), check and see when the exact date of the late payment ding was. When that’s more than seven years ago (right now, stuff in 2000 is starting to vanish from credit reports), it disappears from the credit report. If that’s truly the only negative mark on the report, his score should see some sort of bump after the late payment goes away.

So, what can he do to actively raise his score? The two suggestions you gave are both great ones (check out anything odd on his report and have him get his own credit card and use it regularly for small purchases). You didn’t really specify what the “odd” parts of the report are, but if you don’t know what something is on your credit report, you need to track it down and be sure. My wife and I went through this recently before we went in to get preapproved for our mortgage, and it was a good move.

About your credit score: Yours is 718. Keep doing what you’re doing now and you should be fine. Don’t cancel your oldest credit card, no matter what. If you keep the card paid faithfully and also don’t make other late payments on other bills, it’ll all work out just fine and your score will inch upward. Honestly, though, you don’t have much further to go before housing lenders will be 100% okay with your number.

Another thing that you both should do is really understand how your FICO score works and also know ten common mistakes to avoid when trying to raise your credit score. Both of those articles should offer some great additional advice to help you out. Good luck!

Recently, I received a lengthy email from a reader who had a ton of basic personal finance questions contained within. I thought it might be interesting to start an irregular “personal finance 101″ series to answer and explain some of her questions.

Anyone who has tried to get a loan in the last fifteen years or even anyone who has tuned into basic cable in the last year and a half is at least familiar with the basic idea of a credit score: it’s a number that lenders use to determine what interest rate to give you on your loans. But how does it really work? I’m going to discuss how credit reports work in the United States, but most of the general concepts apply to other countries.

So, what is a credit score? A credit score is a single number that represents how trustworthy you are from the perspective of someone who would lend you money. If you haven’t proven yourself trustworthy, your credit score is low; on the other hand, if you repeatedly show yourself trustworthy (by paying bills on time and such), your credit score will be high.

Who determines a credit score? In the United States, a small number of companies, called “credit reporting agencies,” are in the business of collecting information about you. They do this by exchanging information with companies that offer financial items, such as loans, credit cards, and so forth. The agencies generally care about three things: the money you’ve borrowed, the amount you owe, and whether you’ve been making your payments. They collect this information from everyone you are indebted to and create a picture of how trustworthy you are in terms of credit. In the United States, the three main companies engaged in this business are Experian, Equifax, and TransUnion.

Why? Think of it this way. Let’s say three people walked up to you and asked to borrow $5. You’ve known two of them for years: one is as trustworthy as can be, and the other one is the biggest backstabber and scoundrel you’ve ever known. The third, you’ve never met before. Who would you be more likely to lend money to? Obviously, I’d loan money to the person I trusted, then the person I didn’t know, then the scoundrel.

Now, let’s say you’re a bank and three people come in and ask for a loan. You’re going to want to have some way to determine who is the trustworthy person (who you would want to lend money to), the unknown person (who you would nervously loan money to), and the rogue (who you wouldn’t want to loan money to at all). This is the exact purpose of a credit score: it’s a number that says how trustworthy - or how much of a scoundrel - you are in terms of money.

What makes up a credit score? There are five main elements to the credit score in the United States. From MyFico:

FICO scores are calculated based on your rating in five general categories: Components of the FICO score
Payment history - 35%
Amounts owed - 30%
Length of credit history - 15%
New credit - 10%
Types of credit used - 10%

What can I do to make my credit score better? The biggest thing you can do is pay down your debts, not open up new credit cards and such, and pay everything on time. Many people try all sorts of crazy things, but the truth is that most common moves people make to help their score are mistakes.

Occasionally, I like to highlight comments about various articles on The Simple Dollar for several reasons. One, it lets me highlight some of my best readers and let them know that I really value their comments. Two, it lets everyone else know how integral comments are to The Simple Dollar. And three, after sifting through hundreds of comments, you quickly realize that there are some real gems in there.

On the post Deconstructing Dave Ramsey, Frank did a bit of extra research into Ramsey’s past:

Wikipedia has a nice summary:
“By enacting 26 U.S.C. S 469 (relating to limitations on deductions for passive activity losses and limitations on passive activity credits) to remove many tax shelters, especially for real estate investments, the Act significantly decreased the value of many such investments which had been held more for their tax-advantaged status than for their inherent profitability.”
http://en.wikipedia.org/wiki/Tax_Reform_Act_of_1986

Ramsey was hurt badly by the Tax Reform Act of 1986, but I neglected to fully explain why this had such a detrimental effect on him. Obviously, Ramsey held a lot of investments that had some major tax advantages before the Tax Reform Act but were simply a much worse investment after the act passed. This caused his bankers to question the risky loans Ramsey had taken out to build his portfolio and they demanded payment on a lot of loans at once - which forced Dave into bankruptcy and eventually led him to become the pundit that he is.

On the post The FICO Battle: Ten Common Tactical Mistakes When Dealing With The Credit Score Blues, Wendell wrote:

On what evidence do you base the idea that negotiating with creditors is better than bankruptcy? Negotiation works where you have capital to make a deal immediately; not for stretched consumers who have to accumulate the payments. High-cost negotiation services have popped up that are as bad or worse than bad credit counselors — and they depend on this sort of advise to thrive. The reality is that if your credit score is shot already and you can’t pay the debt off within a couple years, a bankruptcy will rebuild your credit faster.

The advice I offered in the post was to use FTC guidelines when selecting a credit counseling service. A reputable service (like the Consumer Credit Counseling Service) is going to be better for your credit than a service of questionable repute. Also, turning to a credit counseling service should not be the first step in seeking help with your debt; you should call your creditors and discuss various options with them; it’s usually much better for them to reduce your interest rate a bit than dealing with someone who might declare bankruptcy. Remember, bankruptcy stays on your credit history for ten years, while missed payments only last for seven.

Also, on the digg thread higlighting the FICO score post, iamnos had this to say:

Where I am right now, housing is a great investment. If I were to sell my house right now for market value, pay off the existing mortgage, subtract the mortgage payments and property tax I’ve paid since we moved in, I’d be about even. That’s right, that means over the last 6 years, overall, housing for my family, has cost me $0.

Had I not taken out a mortgage, and decided to rent for the last 6 years, I wouldn’t even be close to zero. Around here, a decent two bedroom apartment would have cost at least $800/month. I’d be down somewhere around $57,600, and that’s not including any interest.

For those of you quoting Ramsey, you might want to pay more attention, as he does not consider a mortgage to be debt. Why? Because its secured, and generally, is expected to appreciate in value. While he does mention that the deduction for the interest on a mortgage is not enough to counteract the mortgage itself, you’re still better off in today’s market to invest that money, even in low risk, low return investments, than to try and pay off your mortgage faster. If you’re drowning in debt, this may not be the best idea, but if your debt is very manageable, than your better off planning long term, rather than short term.

This somewhat ties together the “Dave Ramsey philosophy” and methods of getting a good credit score - or even why you should get a good credit score at all. The biggest reason for having a good credit score is to buy a house, and a home loan is one of the few arguably “good” kinds of debt, because that kind of debt is secured (thus it’s not sold at a frightening interest rate) and the asset you buy builds value over time. In general, I’m opposed to debt, but there is a lot of merit to a home loan.

On the post Money Magazine - February 2007, in response to a reference to inexpensive prices when traveling to South America, Jim Lippard had this to say:

I was just in Buenos Aires last week (and had great summer weather)–it’s not just the exchange rate, it’s that most travel-related expenses themselves are much less expensive in South America than in Europe. In particular, eating out in Buenos Aires is quite inexpensive for very high quality meals. And even if you stay in a top-of-the-line hotel and eat in restaurants in touristy areas, the prices are still significantly less than the European equivalents.

My family and I have been quietly planning an international vacation in a couple years and we’re leaning more towards South America by the day.

As always, thank you guys so much for reading and commenting on The Simple Dollar. Not only do I get a lot of value out of your thoughts, so do the thousands of others who visit the site daily. Your input really helps make a difference in people’s financial lives.

When people discover a problem with their credit score, they often act rashly, doing things that seem as though they would improve your credit, but actually damage a credit score. Before we get into the ten mistakes to avoid, let’s first look at what makes up one’s credit score, as defined by Fair Isaac:

Although the exact formulas for calculating credit scores are closely guarded secrets, Fair Isaac has disclosed the following components and the approximate weighted contribution of each:

35%,- punctuality of payment in the past (only includes payments later than 30 days past due)
30% - the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
15% - length of credit history
10% - types of credit used (installment, revolving, consumer finance)
10% - recent search for credit and/or amount of credit obtained recently

Mistake #1: Cancelling old credit cards. 15% of your credit score comes from the length of your credit history. Thus, cancelling your oldest credit card can often be a mistake. Also, if you have balances on other cards, cancelling an old credit card can also worsen your debt ratio, which makes up 30% of your score. If you don’t have other sources of credit that are older than seven years, you should not cancel your oldest credit card.

Mistake #2: Staying current on “most” of your cards. 35% of your score focuses on punctuality of payment, with only payments that are more than thirty days late affecting your score. If you’re going to be late on any cards, make up that payment before it’s thirty days late. Don’t keep up with all but one or two of your cards and let those go later and later; instead, juggle the cards a bit if you have to, but make sure you are not too late on any one card.

Mistake #3: Having too many open lines of credit. 10% of your score comes from the types of credit used. If you have a lot of sources of revolving credit (i.e., credit cards), you can be seen as a credit risk because you have the potential of racking up a lot of debt very quickly. Don’t open store credit cards just to get a discount, and if you have any recent store cards, cancel them once they’re paid off.

Mistake #4: Maxing out your cards. 30% of your score comes from the ratio of your credit card debt and your credit limits. Thus, if all of your cards are maxed out, your credit score is suffering even if you’re keeping up with the payments. Instead of charging and buying more and more, focus on paying down the cards with extra payments.

Mistake #5: Avoiding loans and debts. In the eyes of your credit report, no debt is effectively bad debt. If you’re a credit card teetotaler, you should still consider getting one and making an occasional purchase with it. I have a friend who has one credit card which is associated with his gas station chain of choice. He uses it just for gas purchases, racks up discounts on it, pays it off in full each month, and it helps him maintain a solid credit score in case he needs a loan.

Mistake #6: Requesting a credit limit reduction. Some people believe that they have too much credit and that they’re better off with a credit limit reduction. In fact, the only significant effect a limit reduction has on your credit score is a negative effect on your debt ratio. Only get a limit reduction if it has a huge psychological value for you; otherwise, it will hurt your credit score.

Mistake #7: Utilizing the first credit counseling service you hear about. Quite often, the ones that advertise the most are the ones that do the shoddiest job. Use the FTC’s advice and find a reputable credit counseling service in your area. Call several of them from the yellow pages and ask the questions from the FTC page to find ones that seem legitimate, then check with the Better Business Bureau before moving forward. Remember, your credit score will affect many of your financial moves for years, so don’t skimp out on your research if you’re thinking of using a counseling service.

Mistake #8: Declaring bankruptcy. Many people go forward with bankruptcy because they believe it’s the only way out. Instead of taking such a drastic measure, seek counseling first with one of the more legitimate sources mentioned above. Bankruptcy can really decimate your credit score for a very long time. Quite often, there are better solutions, such as negotiating with creditors and so forth.

Mistake #9: Practicing credit card arbitrage. This game can seriously damage your credit score if you’re not an expert. Shy away unless you’re financially stable and know exactly what you’re doing; if you make a mis-step, your credit score could easily be demolished.

Mistake #10: Never checking your credit report. Most people who behave well with their credit just assume that their credit is fine, but sometimes incorrect things can show up on your report. Visit annualcreditreport.com to get the free report that the United States government guarantees you from the three major agencies. Don’t go to freecreditreport.com; it’s a rip-off.

Due to the enormous impact that credit reports have on the ability of an individual to get a loan, the United States government has made it possible for every citizen to obtain a free copy of their credit report every twelve months. This free credit report was given a great deal of attention over the past few years, and thus many people are at least peripherally aware of the ability to get a free credit report.

FreeCreditReport.com is advertising heavily on television lately, promising to give you this free credit report just by visiting their site. This seems appropriate, right? After all, everyone gets a free credit report… so we just go to FreeCreditReport.com and get it…

Don’t.

Instead of giving you the free credit report that is promised by the FTC, FreeCreditReport.com actually requires you to sign up for a program called Triple Advantage, a credit monitoring program that costs $12.95 a month. This service merely emails you if there is a change to your credit report at a very hefty cost, particularly when the government gives you a credit report for free every year. Don’t like that option? Well, you could instead just pay Experian $14.95 to give you your credit report instead … or, even better, pay $40 and get your report from all three credit agencies.

If you just want to see your credit report, don’t visit FreeCreditReport.com unless you want to pay for something that the FTC has already guaranteed you for free.

So how do I actually get my free credit report? Take a peek at the FTC’s page on the topic. The actual place to go for the free credit report from the federal government is annualcreditreport.com. This is the only site that will actually be able to give you your report without either allowing others to have access to the report or being required to buy other products.

Interestingly, this information is actually stated on the front page of FreeCreditReport.com, but it’s done in tiny blue text on a blue background that makes it almost impossible to read. Coincidence? What do you think?