Chapter 21

Rethinking Credit

When Howard S. realized that he would probably never leave the hospital, he wrote a check for $10,000 on his credit card. His wife Linda cashed the check and, using his previously executed durable power of attorney, purchased a car in Howard’s name. She took credit life insurance on the balance due on the car. When Howard died a few weeks later, credit life insurance paid off both debts. Linda inherited the car free and clear.

 

If you already have credit, protect it—and get more. If you don’t have it—get it now. Get as much as you can, whenever you have the opportunity. Now, more than ever, credit is your friend. You want to be able to access credit when you need it. For example:

• Credit can be helpful in case you have to stop working and your disability income doesn’t start for a time.

• Credit can help you deal with an immediate extraordinary expense.

• Credit card bonuses provide free travel, gifts, and discounts—or give you a cash rebate.

• Credit can be used to increase your life insurance—so you leave more money for your heirs—by paying off debts that would otherwise have to be paid from the assets of your estate.

• Credit disability insurance can help keep your bills current and relieve the financial strain if you become disabled.

As with many things in life, credit is available when you don’t need it, and almost impossible to get when you do need it. If you have a verifiable income, whether you are working or not, this is the time to get all the credit you can. Remember, however, that having credit and using it are two different things. Credit must be used judiciously. You want it for when you need it.

Ideally, only people with a statistical life expectancy of less than two years and credit life insurance on the accounts should carry credit card debt. For everyone else, this section includes a discussion about various strategies for reducing credit card debt.

This is a good time to review the discussion in chapter 3 about checking the information maintained about you in national credit bureaus. It is essential that this information is correct to insure that the credit you want is available. If you haven’t contacted the bureaus, now is the time to do it.

Section 1. Credit Life Insurance

Credit life insurance pays off the amount of outstanding debt owed a particular creditor at the insured’s demise. The amount of the coverage fluctuates up or down according to the amount of the outstanding debt. Credit life insurance is sold with no medical questions and no physical examination of any kind. Premiums for credit life insurance are determined on a monthly basis by the amount of debt outstanding on that credit card that month.

There is no required minimum time between the application for credit life insurance and the beginning of uncontestable coverage. However, as a practical matter, some time is required to permit the insurance company to issue the policy, so it can be effective before death occurs.

Tip. Standard advice about credit life insurance is that it is a “rip-off.” However, for a person with a challenging condition, conventional advice is switched on its head: credit life insurance is an easy means of purchasing life insurance at a time when it is difficult to obtain.

Consumer Purchases. Credit life insurance is available for many consumer purchases that are typically made on credit, such as furniture and automobiles. In these cases, the insurance is usually offered at the time the contract of sale is executed. Rather than fluctuate up and down, the amount of insurance decreases over time to keep pace with the continual decrease in the debt as payments are made. Premiums can usually be financed along with the principal amount of the loan.

Credit cards. Typically credit life insurance is sold by credit card companies. When you apply for a new card, if the company offers this type of insurance, you are generally informed about it when you first open the account. You may also be able to add it after opening the account by contacting the credit card company at the toll-free number listed on your credit card.

You may even be able to obtain check-writing privileges with your credit card account. Like debt that is incurred to make a purchase, debt incurred to cover the check is also paid off at death by credit life insurance.

The ideal use of credit. In an ideal world, all credit card accounts would have credit life insurance on them, and the credit card balance would be paid off every month until just before death, when the balance due would increase to equal the account limit. At death, the credit card company pays off the debt in full. With the check-writing privileges available on most accounts, that could even mean accessing cash. Ellen N. obtained $12,500 worth of cash advances just before she went into the hospital, believing that because of other physical conditions, she would not survive the operation to remove her cancerous lung. When she survived, she paid off the debt. If she hadn’t survived, her heirs would have been $12,500 richer.

Use your credit carefully. Fred B. thought that he had less than two years left to live based on his understanding of his illness. He “maxed out” the balance on twelve of his fifteen credit cards (all with credit life insurance) for a total debt of almost $100,000—thinking that on his death the insurance would pay any outstanding balance. Fred is now doing well on new medication, and his “shortened” life expectancy is not so short. However, he is now contemplating bankruptcy because he is having difficulty servicing his credit card debt. Luckily, he always paid his American Express balance and has three more credit cards with no outstanding balances. If he does decide to go through bankruptcy, he may still have credit on those cards.

Fred’s experience points out several important facts:

• There is always the “risk” that you will outlive your life expectancy.

• It is possible to go through bankruptcy and still have credit and charge accounts. So long as there are no outstanding balances on the accounts, the creditor has no reason to be notified of the bankruptcy and no reason to close the account. There could be closure if the credit company finds out about the bankruptcy.

• Always keep at least one card with credit life insurance free of any debt. Ideally this would be a line of credit that has check-writing privileges. Give a couple of undated, signed checks to a trusted friend. If you go into the hospital or are near death, the friend can then deposit the checks. Should you survive, the cash can be used to pay off the outstanding debt. If the account does not have check-writing privileges, you can accomplish almost the same thing by giving a trusted friend authority to make charges on your account. If the charge is used while you are alive for your medical and hospital bills and/or your other ongoing expenses, if you survive, you are in no worse shape than if you had paid the expenses out of pocket.

• A cash contingency fund is helpful for sunny days as well.

Tip. If you are considering purchasing any big-ticket items and have a statistical life expectancy of less than three years, it is a good idea to conserve your cash and finance the purchase provided that you obtain credit life insurance on the outstanding balance. As discussed in the investment chapter, “cash is king!” Keep your credit in shape by paying the minimum monthly payment.

Section 2. Credit Disability Insurance

Credit disability insurance is good to have, even though it would be considered expensive for people with no health concerns. It pays the monthly minimum due on a credit account for each month during which the cardholder is disabled. This insurance is available from credit card companies without a medical exam or any medical questions and is sold either with credit life insurance or on its own. The coverage usually has a maximum amount it will pay per month (such as $500) and a limited time, such as up to two years. It provides breathing space by paying your monthly debt at a stressful time.

The insurance does not cover charges made after the commencement of disability. Review the insurance contract to determine if there is any waiting period for benefits to begin, particularly with respect to conditions that exist when the insurance is purchased. Generally there is a six-month waiting period—the insured has to work for at least six months before being able to take advantage of the coverage.

Caution. Do not rely on credit disability insurance to pay off your bills. While credit disability insurance will pay minimum balances each month, when you consider the amount of interest and the continuing monthly premium charge for credit life and disability insurance, the outstanding balance will continue to grow.

Section 3. Protect Your Credit

Pay bills on time. Paying bills on time is probably the most important factor in establishing a good credit profile. It can also mean saving money because you don’t have to pay exorbitant interest charges and late-payment fees.

Tip. If you are slapped with a penalty or your interest rate is increased, try to negotiate it away by threatening to take your business elsewhere. It often works—and there is no downside to asking.

To insure that your bills are paid on time, even when you are not at home to pay them:

• Set up a bill-paying system, such as the one described in chapter 5, section 2. Explain the system to a trusted friend or a family member and staple an index card to the folder with instructions outlining the system. If you have to go into the hospital or are away for some other reason, he or she can keep the system going.

• So they will be available in an emergency, sign checks payable to your creditors leaving the dollar amounts blank.

• Arrange for a system of simple transfers from savings accounts to your checking accounts to provide easy access to money when you need it.

• Participate in a bank program that automatically pays bills. Contact your bank to see if such a program would work for you. Balance the costs against the risks, as well as the Life Units you save each month by not having to write the checks yourself.

Protect yourself against credit fraud. Many credit card users have found themselves in credit card hell after a wallet containing credit cards and their Social Security card has been lost or stolen. Only carry the credit cards you need and do not carry them with your Social Security card. In fact, leave your Social Security card at home if you do not need to carry it.

Stability. Moving often and changing jobs frequently is not viewed favorably by creditors. Consider ways of maintaining a stable address. For example, you could use a parent’s address or a family vacation home. Do not use a post office box since it is seen as a negative on credit scoring. When Ronnie R. sold his house and moved into temporary quarters, he asked the people at his old post office to hold his mail for him, which he picked up once a week until he finally found and moved into a new house. There was only one change of address instead of the four that actually occurred while waiting to locate, fix, and finally move into the new house.

Reducing credit card debt. If statistically you have longer than two years to live, the more money you spend on servicing your debt, the less money you have for your investment goals. So do your best to reduce your credit card debt, while keeping all accounts active.

Some suggestions for lowering outstanding balances:

• Cut back on your discretionary spending so that you can redirect money to paying off debt.

• Consolidate the debt that you have under the lowest interest rate possible.

• Consider obtaining a home equity line of credit to consolidate your credit card debt. The interest on credit card debt is not deductible, while the interest payable on a home equity loan is. Be careful—you have to make the commitment to keep up with your debt. A home equity line of credit is secured by your home, so you don’t want to risk foreclosure and possibly lose your home by not paying.

If you have a statistical projection of less than two years to live, don’t worry about reducing the debt on those accounts with credit life insurance. Just keep the outstanding balance below the maximum amount of the credit life insurance, and pay the minimum balances required to keep the account from going into default.

Tip. Determine a realistic period of time, in months, by which you want to get out of debt. Divide the amount of outstanding debt by the number of months. Pay off at least that amount of debt each month. If you miss a month or two, don’t worry. Do as well as you can.

Dealing with creditors. If you are having problems with creditors, try not to panic—there are ways out. See chapter 17.

Cancellations. Simply because you have credit now doesn’t mean that you will have it forever. Sometimes credit card issuers will cancel cards if there is no activity in the account, so move your charges among your accounts over the year.

Even for cardholders who have always paid their bills on time, creditors have closed accounts because the cardholder was delinquent on other accounts listed in their credit reports, or because the card issuer used credit-bureau scoring and concluded that the cardholder was not a good credit risk.

Sometimes credit cards will be canceled for no obvious reason.

Tip. If you have a problem with a credit card issuer, complain to the regulators of the bank that issued it. Banks tend to listen to the regulators, particularly about complaints.

Section 4. Getting More and Better Credit

4.1 If You Have Credit

Do not throw away those applications you regularly receive in the mail. Fill them out and get more credit. Consider two issues in this quest for more credit:

• Do not apply for several cards in a short time. When you apply for a bank credit card, the issuer reviews your national credit bureau report, and that review is noted on your credit report as an “inquiry.” Too many inquiries on your report can mean that you may be denied additional credit regardless of other qualifications.

• If it appears that you will not qualify for a particular line of credit, do not apply for it. The rejection will probably show up on your credit report.

Tip. An easily overlooked source of credit is overdraft protection on your checking account. If you can get it for free from your bank, take it and save it for emergencies.

As you review credit card applications. Look at

• the interest rate. Of course you’re looking for the lowest interest rate. Note that often companies offer low introductory rates that go up after a period of time. Once you pass the introductory rate, simply go shopping again for a better rate.

• whether there is an annual fee. Check the fine print: many cards are being offered without a fee, but the no-fee offer is only for a time, such as a year.

• whether the cards offer credit life and disability coverage. If they don’t, then pass them by.

Sources for information about the interest rates and fees that are being offered by various credit cards are listed in the resources section.

Tip. If you receive an offer for “preapproved” credit, don’t believe it. These issuers don’t have to accept you, and if you get turned down, the rejection will show up in your credit report.

Transfers to a new account. One way of obtaining more credit and lowering interest costs is to contact a bank offering a credit card and tell them that you are interested in transferring an outstanding balance to a new account if you can find a card that has an interest rate better than your existing card and that does not require an annual fee. They will often make a deal to pick up the account.

When you do transfer balances from a credit card, whether into another credit card account or a home equity loan, do not close the old account. This way you increase your available credit and decrease the amount of interest you have to pay on any outstanding balance. Once you have the new account, you can also consider contacting your old bank and trying to negotiate a lower interest rate, advising that you can get a better rate elsewhere. This can also be done at the end of a low-rate period.

The only time to close old accounts is when they are preventing you from obtaining new accounts or there are substantial annual fees. If you have an account at bank Y with 18 percent interest, and bank A offers 15 percent, you will want to move your balance to bank A. However, the combined credit available between your accounts at bank Y and bank A may be more than A believes you should have outstanding. In that case, close the account at bank Y. The objective is to have the maximum amount of credit you can qualify for, with the lowest interest rate available.

4.2 If You Don’t Have Credit—Secured Credit Cards

If you do not have credit because of a poor credit history or no credit history at all, a secured credit card might be the answer to obtaining credit.

With a secured credit card, you are required to open and maintain a savings account as security for your line of credit. The amount of credit is a percentage of your deposit, typically 50 percent to 100 percent, but sometimes even more. For example, if you deposit $1,000 in a bank account, you can charge up to $1,000 on the secured credit card. While you’re not receiving credit to help pay for that transaction, by paying the bank the appropriate amount every month on the “credit card,” and not touching the amount being held on deposit, you’re creating a credit record that you can use to help obtain regular credit accounts. You may even be able to obtain credit life insurance on this account.

Look for a card that pays you interest on the money you deposit, that requires no annual fee, has the lowest interest charge, and does not report the account to the credit bureaus as a secured account. The credit limit should be at least as high as your deposit and preferably higher. To find available cards, see the resources section.

Use the secured card frequently and pay off the balance on time every month for twelve to fourteen months. This will build a healthy credit profile, which you can rely on to help obtain an unsecured card in the future.

Only use a bank for this type of card. There are plenty of disreputable operations that prey on those desperate for credit. They would like to issue you a card with a secured line of credit—and then disappear with your money. Lists are available of reputable banks offering secured cards and the terms. See the resources section.

Once you have obtained an unsecured card. Close your secured account or negotiate with the bank to convert the card to an unsecured line of credit. Once you have an unsecured card, there is no reason to have your money locked into a low-interest or no-interest account.

4.3 If You Don’t Have Credit—Other Methods

Local stores or lending institutions. If you don’t have credit, consider applying for a charge card or a small loan at a local store or lending institution. Ask if the creditor reports transactions to a credit bureau. If they do—and if you pay back your debts regularly—you will build a good credit history.

Cosigner. If you cannot obtain credit alone, you may be able to obtain it if someone who has a good credit history cosigns a loan for you (which means the cosigner is obligated to pay if you do not).