July 26, 2016
When it comes to credit scores, the news isn't good for many Americans. An analysis of scores by the credit bureau Experian found a third of people have what could be considered bad credit.
Having a bad credit score can affect everything from a person's ability to get a job to the loan rates they're offered at the bank. But could it also make it impossible to open a checking account?
The myth of bad credit and bank accounts
While it is commonly believed bad credit will prevent people from opening a checking account, some banking representatives say that simply is not true.
"Bad credit doesn't affect a person's ability to open a savings or checking account at Citizens," says John Rosenfeld, head of Everyday Banking for Citizens Bank. "We have checking and savings accounts available to anyone as long as they meet the minimum amount needed to open the account."
That minimum amount can be as low as $1, Rosenfeld adds.
Steve Novak, senior vice president and director of retail banking at Bryn Mawr Trust, agrees a low credit score usually can't be blamed for a bank denying a request for a checking or saving account.
"Any kid you open an account with has zero credit," he notes.
ChexSystems reports: What you need to worry about
Rather than bad credit, what consumers should be concerned about is their ChexSystems report. That's where banks record which consumers bounced checks, had accounts closed due to unpaid overdrafts or who otherwise owe a financial institution money.
"It's banks helping banks," Novak says.
ChexSystems serves largely the same purpose that credit reports do for lenders. It helps banks determine whether a person poses a business risk or if they are likely to be a good customer. If ChexSystems comes back with a negative report, Novak says banks and credit unions typically consider the following when deciding whether to approve or deny a new checking account:
- How long ago the negative account occurred
- How long the account was overdraft
- Whether the bank was paid back
- Consumer reasons for the overdraft
Every bank has its own criteria but generally those who owed a small amount for a short period of time are more likely to be approved for a new checking account compared to someone who owed significantly more for a longer period or who never paid back the bank.
Account options for people with poor bank records and bad credit
In the event you find yourself on the receiving end of a bank account denial, don't despair. You still have options.
Look into a second chance checking account
Some institutions, such as Wells Fargo and PNC, offer what is known as second chance checking accounts. These accounts may come with certain restrictions or strings attached.
"You may be unable to write checks off the account or to use online bill pay," says Peter McVey, vice president and director of treasury services for Lead Bank. "[You] may be limited a debit card only with no overdraft privileges."
Plus, there could be minimum balance requirements or additional maintenance fees to pay.
If there is no bank nearby with a second chance checking option, Novak says consumers may have better luck getting an account at a smaller institution.
"Big banks…are more hard and fast on rules," he says. "Smaller banks may be more lenient."
Is a prepaid card right for you?
Another, increasingly popular option is to use a prepaid card in lieu of a checking account. Cards such as RushCard and Bluebird tout themselves as bank account alternatives, and money can be directly deposited into a card just as you would with a checking account. Some cards even have online billpay services.
While prepaid cards are an option for those who can't open a checking account, they may be an imperfect solution. By some accounts, the average prepaid card charges $300 per year in basic fees. What's more, some cards don't offer FDIC insurance coverage, leaving money unprotected in case an institution fails. Additionally, some consumers have complained about some prepaid companies locking them out of their account for days at a time.
How to get your bank record back on track
Whether you've had negative reports work against you or not, there are steps you can take to improve your chances of being approved for a new checking account.
Pay back any money owed
The first thing to do, Novak says, is to pay back any money you owe a bank. While that does not erase the ChexSystems report, paying back the money can improve your standing in the eyes of some institutions.
Ask for a savings account instead
Another tactic to boost a tarnished bank record is to request a savings account with an ATM card. Banks and credit unions typically don't have anything to lose by allowing a saving account, and many are willing to open one even for those with a poor banking record. Then, by showing a history of regular deposits and good money management, the institution may be willing to reconsider its decision on a checking account.
"If you've had some prior issues and are listed in ChexSystems, it does not mean you cannot open a bank account," McVey says. "It simply means you'll have to be more diligent in finding a bank or credit union willing to look beyond your past and focus on your future."
Comment: How have you bounced back if you've had a negative bank record?
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July 25, 2016
One of the things that determines the yield on bonds is uncertainty. Knowing the relationship between bond yields and uncertainty can help you get a yield that adequately rewards you for the investment risk you are taking.
A bond is essentially a loan - investors give money to an issuer for a set amount of time, and in return, they get a specified rate of interest. However, an important difference between a bond and an ordinary loan is that investors sell bonds to one another on a daily basis, and changing prices reflect changing conditions. Some of those conditions are general to the market as a whole, while some are specific to the bond's issuer.
Bond issuers are evaluated based on the degree of certainty that they will repay. This degree of certainty is referred to as "quality," and quality is an important determinant of bond yields.
Bond yields: What is a spread?
The global standard for high-quality debt instruments is the U.S. Treasury bond. Other bonds, whether issued by corporations, non-U.S. governments or municipalities are considered to have a higher risk of default. In return, investors demand a higher yield. The extra yield is measured relative to the yield on Treasury bonds and is called a "spread." For example, if 10-year Treasuries are yielding 3 percent and a certain corporate bond is yielding 5 percent, it is trading at a spread of 2 percent.
How high that spread is depends on two things:
1. The creditworthiness of the individual issuer
2. The overall level of optimism about financial conditions
Bond quality and ratings
The general principal is that the lower the quality of the bond, the higher the yield will be.
Quality is formally measured by ratings agencies such as Standard & Poors and Moody's, who use a range of quality ratings to assess the ability of issuers to repay. For corporate bonds, these systems usually are some variation of the type used by Standard & Poors.
The rating system by S&P is as follows:
Highest level of quality: AAA
AAA is the highest level of quality (considered just below Treasury bonds in quality). AA is the next highest, then A, BBB, BB, B and CCC.
Investment grade bonds: BBB and above
Bonds rated BBB or higher are considered "investment grade."
Junk bonds: BB and lower
Those rated BB or lower are considered "junk bonds." As a reflection of the fact that lower-quality bonds trade at higher yields, some people prefer to refer to junk bonds as "high-yield bonds."
Bonds in default: D
Bonds that are currently in default are giving a rating of D.
It should be noted that quality ratings are assessments of an issuer's current financial condition, and not a forecast of its future. Adverse events could cause a downgrade in quality rating, and market prices might anticipate that downgrade before it formally happens.
How bond rating changes can affect yield spreads
Getting downgraded or upgraded in quality rating is one way that yield spreads on a bond can change. Downgrades usually result in wider spreads, which mean lower prices, and the opposite is true of upgrades.
Besides changes in individual issues, the level of optimism in general about lower-quality bonds changes according to economic conditions, resulting in across-the-board changes for yield spreads. For example, due to the Great Recession, high-yield bond spreads went from about 2.5 percent in mid-2007 to over 20 percent by late 2008. This was a particularly extreme swing from high optimism to bleak pessimism. The 2001 recession saw a more moderate rise in spreads, from about 7.5 percent to just over 10 percent.
Low-quality bonds and price changes
A key to understanding the investment characteristics of lower-quality bonds is to remember the relationship between yields and price: when yields rise, prices fall, and vice versa. Because of how quality spreads can widen or narrow so drastically, lower-quality yields tend to be more changeable than higher-quality ones, meaning that lower quality bond prices are subject to more extreme price movements.
From a portfolio standpoint, this means that lower-quality bonds take on some of the characteristics of equities rather than playing the role of sure-and-steady high-quality bonds. Buy a low-quality bond whose outlook improves, and you should be rewarded with a strong price gain in addition to the higher yield that goes with a lower rating. However, if the outlook for a bond you hold worsens, you could be subject to a price decline which could become permanent.
Effectively then, investors need to understand that the lower the quality of a bond, the less it behaves with the certainty of bonds and more with the volatility of stocks. The higher yield being offered should be evaluated in the context of the higher level of risk.
July 22, 2016
The Securities and Exchange Commission on Oct. 30, 2015 opened the door for ordinary investors to put money into crowdfunding opportunities that were previously open only to the wealthy. Now that this door has been opened, should you walk through it?
Investing in small, private companies provides an alternate form of equity to traditional, publicly-traded stocks, and also gives people access to the explosive growth potential of start-ups. In doing so though, it could introduce a whole new element of risk to your investment line-up.
Why the limitations?
Crowdfunding was previously restricted to what are known as "accredited investors," which include individuals making more than $200,000 a year or who have a net worth in excess of a million dollars, not including their primary residence. The SEC has now made it possible for smaller investors to participate in crowdfunding, but only within certain limits.
Why the caution about allowing this form of investment? For one thing, private companies do not have the same level of requirements for audited financial reporting that public companies do, and so there is the potential for unsophisticated investors to fall for a gaudy sales pitch that is not backed up by a sound business model. Also, investing in start-up companies rather than those with a measurable earnings track record carries a much higher risk of failure.
Updated crowdfunding guidelines
While the SEC loosened the restrictions on crowdfunding, it has not eliminated them altogether. Now, people with incomes of less than $100,000 can invest the greater of $2,000 or 5 percent of either income or net worth, which ever is smaller. Those with income and net worth of more than $100,000 can invest up to 10 percent of the lesser of income or net worth, up to a maximum investment of $100,000.
These restrictions apply to all crowdfunding investments in aggregate over any given 12-month period.
Is crowdfunding for you? 7 things to consider
Crowdfunding is trendy, and you could make the argument that it can add both diversification and a new source of growth opportunities to your portfolio. However, you have to ask yourself if you are prepared both financially and emotionally to make the type of investments that might lose most or all of their value.
You also have to ask yourself whether you are prepared to do some detailed analysis of proposed investments, both when you are looking to buy and then regularly thereafter to monitor your investments.
Here are seven things to consider when investing in a private company via crowdfunding:
The SEC investment limits should help make sure crowdfunding investments don't represent too big a portion of your wealth, but given the specific risk of any one of these investments, you should look to spread your money over multiple opportunities rather than depending too heavily on any one.
Very often, these companies won't have an earnings track record yet, which makes valuation difficult. If there are substantial assets involved, you could look at what the investment price represents as a portion of those per-share assets, but more likely you will have to rely on the company management's projection of earnings as a basis for price comparisons.
3. Track record of key people
Since the venture itself is likely to have a limited history when you invest, what you are really buying into is the talent of the key people running the show. Look at their backgrounds for evidence of past success, and also for warning signs such as legal troubles or frequent business failures in their past.
4. Scope of market
Understanding the extent of the market for the company's products or services will help give you a sense of the growth potential.
Look at both the number and relative strengths of competitors to gauge how difficult it might be for a new firm to succeed.
6. Defensible position
If a company has a promising new product or service, think about whether there are patents or other factors which will make it possible for them to defend their market position, or whether it would be easy for competitors to quickly jump in with similar offerings.
Think beyond just what the company is offering, and look at whether they have a viable way of marketing and delivering their wares.
Crowdfunding is no different from other types of investments in this sense: it is not the method of investment that makes something a good or bad idea, but instead the details of what you are buying and how much you pay for that. Don't get too caught up in the growing popularity of crowdfunding to forget to look at the fundamentals.
Comment: Have you considered crowdfunding investments?
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July 18, 2016
Retirement saving is an abstract concept to people who aren't close to retirement age. It's easy to blow off because in the here and now, failing to save does not seem to have any consequences. People need to make it seem more real to get better motivated to save. One way you could do that is by taking a test drive and spend a month on a retirement budget, and see how you like it.
Majority of Americans at risk for saving too little for retirement
Study after study of American retirement savings have shown that the average worker is falling well short of the savings they would need to support their current lifestyles. As a recent example, the Center for Retirement Research (CRR) at Boston College estimated that roughly half (52 percent) of Americans risk not being able to maintain their standard of living in retirement. This is even when taking into account that less income should be needed in retirement than during one's working years.
Why are so many on track to come up short? Just look at the numbers. The CRR found that the average retirement savings of people in their 50s totaled just $110,000. This is disturbing because that age group has most of its saving years behind it, and is rapidly approaching retirement. Using the common rule of thumb that a 4 percent withdrawal rate allows for sustainable retirement assets, these savings would produce just $4,400 a year in retirement income. Even if you doubled this withdrawal rate, which would probably entail drawing the balance down over time, the result wouldn't augment Social Security benefits enough to provide much of a retirement lifestyle.
How to take the retirement budget challenge
To make this more real to you, try to live on the type of retirement budget your current savings would be likely to support. See the step-by-step process below to take the retirement budget challenge:
1. Project your retirement savings amount
Use a retirement savings calculator to project what your current rate of savings plus investment growth would add up to by the time you retire. This will tell you the total retirement savings you are on track for currently.
2. Figure out what yearly spending your savings can support
Again, 4 percent withdrawals are considered sustainable, but since it is not realistic to expect that everybody will be able to afford to live off their retirement savings without drawing them down. So, you might want to use a higher assumption, perhaps something between 4 percent and 8 percent. Applying this percentage to your projected savings tells you what your annual retirement income your nest egg would produce.
3. Be realistic about Social Security income
You can go to the U.S. Social Security Administration website and get a projection of what your retirement benefits will be. In the end, those benefits are based on the 35 highest-earning years of your career, so if you plan to retire early or if your income drops off later in your career, those benefits may not be as high as you think.
4. Make a budget based on your projected annual allowance
Your income from retirement savings and your Social Security benefit is what you would have to live on. Now create a monthly budget based on that amount.
5. Spend a month living on that budget
As an experiment, try living on that budget for a month. Don't take it so far that you fail to pay bills that you already owe, but limit any discretionary spending to what that budget would allow.
6. Figure out a budget you can live with
If your retirement savings rate is as meager as most Americans' rates, chances are you won't find that budget is very doable. So, figure out how much retirement income you would actually need to have a decent lifestyle.
7. Work backward to see what you need to save
Go back to the retirement calculator and see how much you would have to save to get to a workable retirement income. The experience of trying to live on less might just motivate you to ramp up your savings accordingly.
One way to think about this exercise is that it should encourage you to narrow the gap between your lifestyle now and the one you will be able to afford in retirement. If you get a taste of what it would be like trying to get by on a lot less money, you might decide it's better to spend a little less now, in order to afford a retirement budget that is less of a steep drop-off from how you lived during your working career.
Comment: Have you tried the retirement budget challenge? Tell us your experience below.
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July 15, 2016
Often, people become aware of their credit score only once it has become a problem. For example, a loan or other application gets turned down, and you find out about reports with more detail on your financial history than you remember.
Rather than wait for your credit report to become a problem, learn more about your score and manage it to your advantage.
What financial factors make up a credit score?
Credit scores are a commonly used way to measure credit risk. In order of importance, here are the components that make up a credit score:
1. Payment history
At 35 percent, this is generally the largest portion of a credit score, though scores are weighted differently depending on how relevant each component is to an individual's situation. Your payment history takes into account how well you've kept up with payments on credit cards and loans in the past. It also looks at whether you have any history of bankruptcy or debts referred to a collection agency.
2. Amounts owed
The amount of money you currently owe generally will comprise 30 percent of your credit score. This includes:
- How many different accounts you owe money to
- What percentage of your available credit you are using (AKA credit utilization)
- What portion of any existing loans you have paid down
3. Length of credit history
This will usually represent 15 percent of your credit score. It takes into account your oldest and newest sources of credit, as well as the average age of all your credit accounts. Note that from a credit utilization standpoint and in terms of the age of your accounts, closing old accounts might actually be counter-productive.
4. Credit mix
Around 10 percent of your credit score will be based on the type of credit accounts you have. It is considered beneficial to have a mix of credit card accounts and installment loans (such as a mortgage or student loans), as long as you have a good payment history with them.
5. New credit
Another 10 percent or so of your credit score is based on how many new accounts you have opened recently. Opening several new accounts in a short period of time can be a red flag.
The connection between credit history and creditworthiness
Credit scores are useful because they take a number of factors and boil them down to a single, readily comparable number. There has been a movement in recent years to encourage lenders to consider other factors when a person has had limited access to credit in the past. In any event, credit score is not the only thing a potential creditor is likely to look at.
To a large extent, credit scores represent your history with credit, while overall creditworthiness is a function of both your past performance and your future ability to repay the loan. Income (particularly your income in proportion to your overall financial obligations) is an important factor in creditworthiness, as is the length of time you have held your current job.
4 keys to good credit
Obviously, there are many things that impact creditworthiness, but there are four things that should increase your credit score:
1. Work to establish a good credit history
You might think of having no debt as being a sign of financial rectitude, but to potential creditors it simply means you are an unknown. Establishing a history of modest borrowing and timely payments shows that you have had successful experience with managing credit.
2. Think before you open or close an account
A big part of what creditors are looking for is stability, so be aware that too many changes, like closing older accounts, can upset that stability.
3. Make your payments on time
It's not enough that you eventually pay off your debts - you have to demonstrate that you generally make your scheduled payments on time. Use automatic bill payments if they help you keep on track, and maintain a regular schedule for paying your bills.
4. Focus on paying off balances
Don't take on debt simply because you can make initial or minimum payments. Budget for the future to make sure you can pay down the debt within a reasonable time and make any balloon payments that you'll face in the future.
Maintaining good credit impacts more than your ability to qualify for loans and credit cards. It can also affect your insurance rates, and may be a factor that potential landlords or employers look at as an indication of your reliability. Because your financial history is such a big factor in determining creditworthiness, it is something you have to start managing even before you have a need for credit.
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