Your Money Book

If you visit a marriage counselor, should that affect your credit score? OK, how about a massage parlor charge on your credit card? According to a lawsuit by the Federal Trade Commission (FTC) against credit card issuer CompuCredit – it happens.

Every lender uses a credit score, but even for the widely used FICO score, nobody fully knows what goes into calculations of the formula.

Others use internal proprietary models, and the FTC lawsuit against CompuCredit alleges “deceptive” marketing practice and provides a great (or ugly) insight into the secret business of credit scoring.

In this case, it is about their Aspire Visa cards for subprime borrowers. What the FTC alleges in the suit is that the company didn’t disclose that they closely monitor spending patters and reduce credit lines if cards are used at certain places that trigger a “problem.” Some of them allegedly include tire shops, massage parlors, bars and marriage counselors.

Yes, all card issuers look at your spending patters, amounts, and the places you spend money on your credit card. But the concern is that they may affect your credit in biased or unfair ways as a result. It’s CompuCredit’s second lawsuit, the first was in New York, and was settled for $11 million over its marketing and billing procedures.

Credit card issuers have been quietly reducing credit card limits in any event, mostly without ever notifying customers in advance. With some card issuers running 10% arrears, small wonder. And somehow they’re surprised delinquency is skyrocketing when they were handing out credit cards like candy?

The majority of limit reductions appear to be in geographical areas hardest hit by the housing troubles, including Florida, California, Arizona and Nevada. It is another important reason never ever to have all your financial eggs in one basket – with one card issuer. A lower limit reduces your available credit – the percentage you owe vs. your total available limits and that’s around one-third of your credit score.

Card issuers are pretty jumpy these days and want to prevent losses down the road, rather than just writing off more and more balances reactively. According to the Wall Street Journal, American Express appears to have a new software program that may kick in to reduce limits should cardholders use their credit card at Wal Mart or Marshalls, for example.

It’s only a guess, but it appears that Amex believes charges at these two stores, for example, may predict problems down the road. Is the company thinking their card holders may be in trouble shopping at the “lower-end” stores, or is it a drastic overreaction and incorrect predictor? Time will tell, but I’ve used my Amex card at Wal Mart for decades. It isn’t about financial trouble, for me it’s about avoiding it, by not getting overcharged at other retailers.

Late last year we talked about the coming opportunities of buying real estate in the U.S. At that time, it seemed reasonable to be talking the fall of this year.

But you can forget that. The mortgage problems aren’t anywhere near an end and right now the problems are feeding on themselves and making things worse and not better.

There are a ton of foreclosures, averaging around 7,000 A DAY, and that’s bad enough by itself. But what’s happening now is that people who have been paying all the way along are becoming hard-pressed and discouraged.

They’ve seen foreclosures all around them but have been paying on a home that’ worth nowhere near what they owe. Ballpark? $50 to $100,000 or more in the hole. So many of those are now mailing back their keys and giving up. Banks call it jingle-mails as the keys are mailed back to them.

Others, and in growing numbers, are looking down the street at a foreclosure. That house, same street, so probably very similar in size, etc. is now $100,000 or so less than they owe! So many people are now buying that foreclosed home, setting up the mortgage and then sending back the keys to their home. Yes, this buying and bailing as it’s called, wrecks their credit rating, but they’ve first bought another home on the same block.

It’s not right, it’s not moral, but it’s happening in ever increasing numbers while Congress keeps coming up with bailout plans, the vast majority of which are designed to help lenders and not homeowners.

It doesn’t help that mortgage lenders are totally overwhelmed and often don’t even return calls, never mind helping homeowners restructure their loans and the whole process keeps feeding on itself: Foreclosures get dumped on the market at any price, more people are forced to re-finance at higher rates they can’t afford, seeing their home dropping more and more in value as foreclosures surround them, giving up on their payments, which puts even more houses into foreclosure.

Oh, and a recent survey reports that about half of all foreclosures have significant damage such as ruined floors, carpets, holes punched into walls and missing appliances, all of which reduce the home values by about another 25%, according to the survey.

In Miami, the home inventory is about three years, based on normal sales volume – and what on earth is “normal” these days. And even in Arizona, it’s more than a years’ worth of surplus inventory.

So hurry up and wait…maybe next fall if you’re thinking of buying down there.

Last week we talked about the nightmare of the bankruptcy of Lehman Brothers, the sale, or give away of Merrill, and the $85 billion loan injection into insurance giant AIG.

There are some big lessons for all of us individuals, as well. Sure, our first thought is about our mutual funds and RRSPs. But how many of us live on credit and are buried in payments of one kind or another?

As long as our income keeps coming in, we’re fine. But what happens when we have to do without a paycheque for two months? That’s the same as cash-flow problems for companies.

What are the odds of doing well, over the long term, if we use borrowed money to do our investing? Now, it’s fine to get a one-year RRSP loan, that’s different. But how many e mails do you want from people who look a line of credit to buy gold at around $1,000 an ounce and it’s now around $800? How many examples would you like of second mortgages to buy tech stocks in the 90s because they were never going to go down and people didn’t want to get left out? It is not investing – that is gambling, pure and simple. When someone jumps out of a 50-storey building, for 49 floors they can convince themselves they can fly. But then reality re-appears in a hurry when they hit bottom.

It’s called leverage and it’s a very dangerous shell game. One of the bankrupt firms was leveraged 33 to 1. That is: for ever dollar of assets, they borrowed $33. When shares, or in their case, these mortgage portfolios they invested in, were going up they were making a ton of money. But with a 33 to 1 ratio if investments drop three percent – that’s all – three percent – their entire assets are wiped out.

When you invest with cash – that’s the most you can lose. When it’s on margin, through leverage, you can be wiped out AND still owe a ton of money after all your cash investment is gone!

The good news? These days the rich will absolutely get richer! Why? There are a bunch of companies who have been around for decades whose stock is trashed for no reason. They have great dividends and their shares just got sucked down with the whole market.

Could you have been one of the rich people? You bet. If you’d have the cash to put into savings instead of paying the credit card, the mortgage, line of credit or the car payments.

Last week we talked about the personal lessons about credit and debt that are there for all of us to learn from but I also got yelled at.

I was doing a phone in show and a caller told me I was crazy: That credit is a great tool to get rich. His point was if you just get a number of lines of credit from different banks you can buy a home and flip it right away without ever having to put up any money.

Sorry, credit won’t help you get rich. It’ll help you go broke. And ironically, the day after, Alan Greenspan, the former Chairman of the Federal Reserve was quoted as saying that no country can become wealthy through credit.

Merrill Lynch tried that: They were leveraged 33 to 1. That is, for every dollar in assets, they borrowed $33. On the way up, that’s a 33% return when it should have been a 1% return using cash. But on the way down, anything drops by just 3% and their entire assets are (and were) wiped out.

We won’t get it as bad as the U.S., but right now in Vancouver it takes a $700,000 income to service an average priced $900,000 house. That’s not affordable for 95% of people! Something has to give or there just won’t be any more buyers! And that’s an average house!

At some point, incomes have to come way up or prices way down. It’s the same thing as happened in the U.S. and right now, Vancouver condo listings now up 100% and sales down 50% for just that reason. Want to take a guess as to how many people in Vancouver, who bought in the last few years have almost no money down and a 40-year mortgage?

Credit is buying something you cannot afford to pay for. Simple as that. It doesn’t make all credit bad but it’s really great to be a little bit pessimistic when it come to financing anything. A “what if” attitude is a real positive to consider BEFORE financing anything – because afterwards it’s too late – as millions of Americans are now painfully aware of.