The article entitled “Debunking the FICO and credit score myth” generated some great questions. I would like to answer a few of those questions in this article. Before, I answer the questions, I think that it’s important to note that before I was a consumer advocate, I was a banker. I’ve learned the tricks of the trade from the trade experts. Convincing myself of the fact that credit can magnify my mistakes, reduce my standard of living, tie up my income, and transfer my future wealth from my pockets to the banks was no easy task. When you become serious about building wealth or if you become victim to the misuse of credit, you’ll come to understand my position on this subject.
Question—Damon, as a small business owner I need a line of credit. My line of credit allows me to take advantage of bulk discounts. It also helps when I’m struggling to cover payroll and it’s a lifesaver during those sluggish months.
Answer—As a small business owner, I understand the volatility and unpredictability of cash flow. As you know up to 80-percent of all small business fail in the first 5-years. According to my research 96 percent of those companies that fail is the result of managerial incompetence—49-percent is due to poor marketing and 47-percent is due to poor cost controls. If you had a strong marketing campaign with great cost controls, you can quickly build a cash-reserve or business emergency fund to take advantage of bulk discounts and/or help navigate though sluggish months. Your line of credit may also be overshadowing the fact that you have other core managerial issues. For example, you may have an over supply of inventory or you’re tuning your inventory over to slow. You may also be experiencing what is known as aging receivables due to customers not paying on time. You may be overstaffed. Many of the small businesses that I read about that withstood the test of time started small and used the earnings from the business to grow. Microsoft and Walgreen come to mind. As of 2003 both Microsoft and Walgreen were operating debt free. Your credit line may be giving you a false perception that your business is doing well. If you don’t check the core managerial issues, you may run the risk of closing shop because of your inability to service your debt.
Question—I think I was able to afford a second home (asset) because I took advantage of a low interest rate and no PMI—all because my credit score was 900. It really helped me negotiate, shop and find the best deal without being dictated on which mortgage to select. It also allowed me to afford a second asset by reducing the mortgage to 20 years. I think you should recommend that you master “the system” debt free to get what you want? Additionally, credit is not a bad thing when used with great talent and reserve. I am flying out of town for the holidays, with a direct flight, spending a week in a hotel and renting a car. It’s only costing me $10 thanks to the points I gained by using a charge card that I pay off every month. Is it because credit is hard to control by most?
Answer—I’m proud of your diligence in money management. You’re in no danger of bankruptcy. Robert Kiyosaki and I disagree on some financial principals and methodologies. There is one thing he says that I agree with. He defines an asset as something that puts money in your pocket and a liability as something that takes money out of your pocket. Is your second home (asset) putting money in your pocket or taking money away from your pocket? Based on the IRS rules for second homes, it’s safe to say that you’re not receiving substantial rental income to offset the cost of the mortgage, taxes, insurance and upkeep of the property. If my assumption is correct, your second home (asset) is taking money out of your pockets. You may be looking at the appreciation on the property as a return on your investment. Appreciation is hard to cash at the bank. The only way you can access the appreciation is to sell the property or take out a loan against the property. Depending on what your goals are, the payments you’re making on the second home may be better directed toward another investment vehicle that put money in your pocket and offers less risk, a better return and more liquidity. Regarding the credit cards and points you earned. One of the reasons credit card companies created the point system is to entice you to use your card and spend more. When you do the math for the plane ticket you basically got for free, you’ll learn that based on the activity on the card that awarded you the free ticket, you could of paid for 10 flights and had change left over. Most of those cards pay you 1 percent of the activity on your account. Assuming that your free flight is valued at $500, it means you moved $50,000 through your credit card to earn those points. The Credit Card Company had a plan. They got what they wanted—$50,000.
During a church service a young gifted pastor was sharing a touching story about some inner city kids who thought the pastor was some type of drug dealer after seeing his luxury automobile. The inner city youth asked, “What do you do?” The pastor responded, “I work for God.” The youth said, “You could get that working for God?” The pastor said, “Yes, working for God and keeping up your credit, you can purchase a nice car like the one I have.” Inspiring story. I have to admit that as the pastor was sharing the story, I thought to myself, the scripture says, “You can do all things through Christ, who strengthen me.” Not you can do all things through Christ and with good credit.
(Mortgage and Money Coach Damon Carr is owner of ACE Financial. Damon can be reached at 412-856-1183.)