lending

This Is the Difference Between a Loan and a Line of Credit

Dan Rafter — Mon, 14 May 2018 08:31:14 +0000

Maybe you need some money to fund the renovation of your home's 1970s-era kitchen. Or maybe you need a quick chunk of cash to pay down high-interest credit card debt or help pay for your kid's college tuition. Should you get that cash from a loan or a line of credit?

You may wonder what difference it makes, but there actually is a difference. And both forms of borrowing come with positives and negatives.

Before you take out either a line of credit or a loan, it's important to understand the key differences between the two.

Loans give you a single lump-sum payment

The main difference between a loan and a line of credit is in how the money is dispersed with each option. In a loan, you'll receive a single lump-sum payment. You pay back the money you've borrowed, with interest, each month over a period of years.

Taking out a mortgage to finance the purchase of a home is a good example. Your lender provides you with a single payment that you use to buy your home. You then send a check to your lender each month, paying back the principal balance of that loan along with interest.

Other common types of loans include auto loans, student loans, and personal loans. In all of these products, you're given a big chunk of cash that you steadily pay back with regular payments.

Lines of credit act more like credit cards

With a line of credit, a lender approves you for a maximum amount of dollars that you can borrow. But you don't have to borrow up to the maximum. You can instead borrow whatever you need to pay for home improvements, paying off other forms of debt, helping your children with their college tuition, or whatever other expense you need the money for. With a line of credit, you only pay back what you borrow.

A home equity line of credit, better known as a HELOC, is a good example. Your lender will approve you for a maximum amount that you can borrow based on the equity you've built up in your home. Say you have $100,000 of equity in your home. Your lender might approve you for a line of credit up to $80,000.

If you want to borrow $20,000 to remodel your bathrooms, you borrow that amount, leaving $60,000 still available for future projects. Once you borrow that $20,000, you have to begin paying it back in monthly installments, with interest. (See also: 5 Questions to Ask Before Applying for a HELOC)

With loans, your payments are (mostly) fixed

With a typical loan, you usually know what your payment will be each month. If you borrow $20,000 to buy a new car, you'll make the same payment each month — a payment in which your dollars will go toward paying down your principal balance and paying off interest — until you've repaid the loan.

With a line of credit, your monthly payment will vary depending on what you've actually borrowed. If you've only borrowed $10,000, your monthly payment will be smaller than if you've borrowed $50,000.

The exception with loans, though, can come with a mortgage. Even if you take out a fixed-rate mortgage in which your interest rate remains the same over its life span, your monthly payment could fluctuate. That's because lenders usually require borrowers to also include payments for homeowners' insurance and property taxes with their mortgage checks. If your taxes or insurance costs rise or fall, your monthly payment might fluctuate.

Your mortgage payment could also change if you take out an adjustable-rate mortgage. With these loans, also known as ARMs, your interest rate will change during the repayment period, causing your monthly payment to rise or fall accordingly.

Interest rates are higher on lines of credit

Loans tend to come with lower interest rates than lines of credit. As an example, Freddie Mac, in its primary mortgage market survey, said that the average interest rate on a 30-year, fixed-rate mortgage as of the week ending April 26 stood at 4.58 percent. For a 15-year fixed rate mortgage, the average rate was 4.02 percent.

At the same time, home equity lines of credit are currently averaging interest rates of over 5 percent.

Closing costs are higher with loans

You'll usually spend more upfront to take out a loan than you will to originate a line of credit.

Loans typically come with higher closing costs — fees that lenders and third-party providers charge to create your loan. A good example is with mortgage loans: You can expect to pay about 3 percent of your total loan amount in closing costs and fees. (See also: Here's What's Included in a Home's Closing Costs)

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This article is from Dan Rafter of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5-Minute Finance: Checking Your Credit Score

Dan Rafter — Tue, 24 Apr 2018 09:00:07 +0000

Your credit score is one of the most important markers of your financial wellbeing. A strong score will net you the best interest rates on car loans, a mortgage, and credit cards. A weak score can leave you struggling to get approved for financing at all.

It's vital that you regularly check your credit score and make efforts to keep it on the up and up. Not sure how to do this? It's easy. All you need is five minutes.

What is your credit score?

You actually have several credit scores. FICO credit scores are the ones that most lenders check, but there are even several different FICO scores. The most common one that lenders use today is the FICO Score 8. VantageScore is another type of credit score that lenders use. Both FICO and VantageScore use a scale of 300 to 850.

Each three-digit credit score that you have is generated using the information in your credit reports. They serve as a designation of your risk level, and tell lenders whether you have a history of paying your bills on time and managing your credit well. If you have a strong credit history, your score will be higher. If you have managed your finances poorly, your score will probably be low.

In general, most lenders consider a FICO credit score of 740 or higher to be a good one. A score under 640 could make it difficult to qualify for auto or mortgage loans or earn the best credit card offers.

Why you should check your credit score

Knowing your credit score is important, especially before you plan to make any large purchases or try to qualify for financing. If your score is low, lenders might not approve you for that loan at all. If they do, they'll charge you higher interest rates to protect themselves from the increased risk they are taking on by lending to you.

With higher interest rates, your monthly payments on mortgage, student, auto, and personal loans will be higher. Your credit cards, too, will come with higher interest rates, which will cost you if you carry a balance on them each month. If you know your score is low, you can take steps to steadily build it before you apply for new loans or credit cards.

It's also important to keep an eye on your credit for any strange activity. If your score suddenly plummets due to a late payment you know you made on time, it's important to take steps to correct the mistake on your credit report ASAP.

How to check your credit score

You can order your FICO score from myFICO.com. Depending on how much information you request, ordering your score can cost you from $19.95 to $59.85. For $19.95, you can order your FICO score from one of the credit reporting bureaus: Experian, Equifax, or TransUnion. For $59.85, you can order your FICO score from all three credit bureaus.

You can also order your FICO score directly from one of the three credit bureaus. Again, you'll have to pay for this, and be careful to read the fine print. For example, Experian offers your FICO Score 8 when you order a $1 copy of your credit report — just be aware you'll be automatically enrolled in their CreditWorks credit monitoring program, and will be charged $21.95 a month if you forget to opt out. Experian also offers the option to order FICO scores from all three bureaus for $39.99. The other bureaus charge similar prices.

Several websites, such as CreditSesame, also offer free credit scores. These scores might not always be the official FICO scores that lenders use, but they will still give you a ballpark idea of how strong or weak your credit is. Just make sure that the site you order your free scores from doesn't ask for your credit card number. If it does, you might accidentally sign up for a credit monitoring service that will charge you each month until you remember to cancel it.

Your credit card provider might also provide you a free version of your credit score. Again, this might not be an official FICO score, but it will also give you a sense of whether you need to work on improving your credit.

Next steps

Once you know your credit score — or at least one of them — it's time to take steps to improve it. You'll have to practice sound financial habits over time to see an improvement.

The best way to boost your score is to make all of your payments on time. If you build a long record of on-time payments, your score will gradually improve.

At the same time, work on paying down your credit card debt. Your score will suffer if you have too much revolving debt, so work to chip away at it as best as you can. Always make more than the minimum required monthly payment. You'll never pay down your credit card debt by only paying the minimum.

Don't close credit cards you aren't using. Closing an account will automatically boost the percentage of your available credit that you are using, which will cause your score to fall. But don't ignore your credit cards, either. Buying items with your card and immediately making your payment is a great way to build your score. Make sure you only charge what you can afford to pay back in full each month.

Additional resources

Five Ways to Improve Your Credit Score Fast

Is It Worth Paying for Your Credit Score?

FICO or FAKO: Are Free Credit Scores From Credit Cards the Real Thing?

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This article is from Dan Rafter of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5 Surefire Ways to Maintain a Good Credit Score in Retirement

Dan Rafter — Thu, 29 Mar 2018 09:00:06 +0000

You're nearing retirement. Once you hit this milestone, you won't have any reason to worry about your credit score, right? Not exactly.

Maybe you expect to have your auto loan and mortgage paid off by the time you hit retirement. Maybe you don't even expect to apply for any new credit cards once you leave the working world. But what you plan is often far different from what actually happens.

What if you haven't paid off your mortgage by retirement and you want to refinance your existing loan to one with a lower mortgage payment? You'll need a good credit score. What if your car breaks down and you need to buy a new one? If you want to finance the purchase of a new car, you'll need a solid credit score to qualify for an auto loan.

There's good news here, though: Keeping your credit score high during your retirement years doesn't have to be difficult. You just need to remain diligent about paying your bills on time and using your credit wisely. Here are some ways you can do that.

1. Keep using credit

You might decide after retirement to live an all-cash lifestyle. This makes a certain amount of sense: You're on a fixed income, and you certainly don't want to run up debt on your credit cards. Paying for everything in cash will prevent that from happening.

But if you don't use credit, your credit score will start to suffer. You build a strong credit score by using credit wisely. If you don't use it at all, how can you prove you remain a good credit risk after leaving the working world?

This can be especially difficult in retirement. If you don't have a mortgage or auto payment anymore, you won't be making as many monthly payments to boost your credit score. So, it's a best practice to keep using your credit card regularly to make some purchases. But only charge what you can afford to pay off in full each month. When your credit card bill is due, pay off your entire balance, and do so on time. This way, you demonstrate good credit skills while also avoiding credit card debt. (See also: Why Your Credit Score Matters in Retirement)

2. Don't close credit card accounts you don't use

After retirement, you might not use as many credit cards as you did while working. You might even consider closing those credit card accounts that you no longer use. Resist this urge, though.

A good chunk of your credit score depends on how much credit you are using. This is known as your credit utilization ratio. The more of your available credit you are using, the worse it is for your credit score. If you close an open credit card account, even one you no longer use, you will immediately increase your credit utilization ratio.

Let's say you have three credit cards, each with a limit of $5,000. That means you have $15,000 in total available credit. Now let's say you owe $3,000 in credit card debt. You have a credit utilization ratio of 20 percent ($3,000 divided by $15,000), which is considered good — lenders typically like to see this number under 30 percent. If you close one of your cards, you will automatically lower your total available credit to $10,000. Now, owing $3,000 out of $10,000 just bumped your credit utilization ratio up to 30 percent, all without you spending a cent.

You don't have to use the credit cards that have been sitting untouched in your wallet. But you shouldn't close those accounts, either. (See also: How to Close a Credit Card Without Dinging Your Credit Score)

3. Be careful when co-signing

It's natural once you hit retirement to want to help your children or grandchildren financially. But be careful when one of your relatives asks you to co-sign on an auto or mortgage loan.

Young adults often have limited credit histories and it can be difficult for them to qualify for financing. They often turn to co-signers — usually a parent — for help. Lenders are more likely to approve their loan requests if someone with a longer, more established credit history is signing up for the loan, too.

There's a huge problem with co-signing. If the person you're helping doesn't pay the bill, those late payments go on your credit reports. You are now equally responsible for this new debt. And if your relative defaults on the loan? You'll be the one on the hook.

Co-sign with caution. It is very rarely an advisable move, and can land your credit score in hot water. (See also: When Should You Co-Sign a Loan?)

4. Check your credit reports

You might not think much about your credit in retirement, but you should still check your three credit reports once every year.

You can do this for free at AnnualCreditReport.com. Make sure to order copies of each of your three credit reports — from Experian, Equifax, and TransUnion — as each might have slightly different information.

Check the reports for any mistakes. Maybe a report lists that you missed an auto payment last year and you know you haven't. Correct the mistake by notifying the offending credit bureau. You can do this through email. A mistake on your credit report can cause your credit score to plummet.

It's also a good habit to monitor your reports for accounts you did not open. If something looks suspicious, you may have a case of identity fraud on your hands. (See also: How to Read a Credit Report)

5. Keep paying those bills on time

The last step to keeping your score high during retirement might be the most important: Keep paying your bills on time each month.

Of course, this is good advice for anyone trying to maintain a good credit score. A single missed payment on a credit card account, mortgage loan, auto loan, or student loan can cause your credit score to fall by as many as 100 points. So even after you leave the working world, keep making those payments on time. (See also: 3 Ways Retirees Can Build Credit)

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This article is from Dan Rafter of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

How to Benefit From Rising Interest Rates

Rachel Slifka — Wed, 21 Mar 2018 09:30:19 +0000

Interest rates went up three times in 2017, and they are under consideration to be increased yet again within the next couple of months. As interest rates continue to rise, what does that mean for you as a borrower?

While rising interest rates means it costs more for you to borrow, it also can work in your favor. Here are a few examples of how The Federal Reserve hikes can benefit you financially.

1. Throw more into savings

Savings accounts and certificates of deposit have been at historically low interest rates in the past few years. While a hike in federal interest rates won't make you rich, it can give you a slight boost in your savings power, for no extra work. (See also: Best Online Savings Accounts)

As interest rates increase, now is a great time to start socking extra money away into savings accounts and CDs. While putting extra money into savings might not result in as much interest earned from other saving avenues, such as retirement accounts or other investments, you can use the higher interest rates as an incentive to boost your savings or emergency fund contributions.

2. Take advantage of still low interest rates

During the financial crisis of 2007, the credit bubble burst, causing lending to come to a near halt. The Federal Reserve drove interest rates to the floor, and eventually pulled lenders back from the brink.

Higher interest rates today may make it more expensive for borrowers than over the past several years, but rates are still near historic lows. While it's important to use caution when borrowing money, now might be the time to strike if you've been on the fence about making a big purchase, such as buying a home.

3. Get more bang for your buck abroad

Traveling abroad can be expensive enough in its own right. But as federal interest rates rise, it could very likely strengthen the U.S. dollar.

A stronger dollar means Americans can travel abroad and get a better exchange rate than usual. Thanks to exchange rates working in your favor, you can splurge a little bit more (or save more) than you had maybe originally budgeted for.

4. Pay off consumer debt

The interest rates on your debt will rise if the Fed continues to increase rates. This means you will be required to pay even more interest on your debt, owing more money overall.

You can lessen the blow by prioritizing your debt repayment now. The sooner you pay off debt at a lower interest rate, the more money you will save. Use the threat of increasing rates to get your debt paid off as soon as possible.

Credit card debt is especially susceptible to climbing interest rates. Credit card debt has its own high interest rate, so any additional increase from the Federal Reserve will only cost you more. Avoid paying extra interest by prioritizing debt repayment today. (See also: The Fastest Method to Eliminate Credit Card Debt)

5. Consider refinancing

If you've been considering refinancing your home or auto loan, you may want to do it before the Fed considers another increase. In addition, if you bought your home at a higher interest rate and have not yet considered refinancing, you may not be getting the best deal available.

Even if federal interest rates don't change again, you may still find it advantageous to refinance your mortgage or auto loan to a better rate. (See also: 4 Smart Ways to Lower Your Monthly Mortgage Payment)

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This article is from Rachel Slifka of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5 Questions to Ask Before Applying for a HELOC

Dan Rafter — Tue, 16 Jan 2018 09:30:10 +0000

You've paid enough on your mortgage to build a solid amount of equity in your home. Now you want to tap into it; maybe you want to use the money to pay off high-interest credit card debt, help fund a child's college education, or take on a major kitchen remodel.

You have two choices when it comes to using that equity: a home-equity loan or a home equity line of credit. These are two very different options, but many homeowners prefer the flexibility that comes with a home equity line of credit — better known as a HELOC — instead of the lump-sum payment they get with a home-equity loan. (See also: Home Equity Loan or HELOC: Which Is Right for You?)

But before you apply for a HELOC, make sure you answer a few key questions.

1. Do you know how a HELOC is different?

Equity is the key to both home-equity loans and HELOCs. Say your home is worth $250,000 and you owe $180,000 on your mortgage. You have $70,000 worth of equity.

Your lender might approve you for a home-equity loan of $50,000. You'd receive that money in a lump sum. You'd pay it back each month, with interest, just like you do with your primary mortgage.

A HELOC works differently. It acts more like a credit card, with your credit limit based on your home equity. If you have that same $70,000 of equity in your home, a lender might approve you for a HELOC of $60,000.

Instead of getting a lump-sum payment, you'd get that $60,000 in the form of a line of credit, and only pay back what you borrow. If you used $30,000 to remodel a kitchen, you'd only pay back that $30,000, with interest. If you used the full $60,000, you'd have to pay that amount back.

2. Do you mind a bit of uncertainty?

Another difference between home-equity loans and HELOCs is that the former come with fixed interest rates, while lines of credit usually have variable interest rates. This means that your initial interest rate will usually be lower than what you'd get with a home-equity loan.

But that initial rate will change over the life of your loan. It could — and usually will — climb depending on what economic indexes your rate is tied to. For instance, if your HELOC is tied to the Fed's prime rate, it will adjust every time the Federal Reserve adjusts this rate. Most HELOCs adjust either on a monthly basis or a quarterly one, rising or falling depending on the index to which it is tied.

Home-equity loans come with initial higher rates, but these rates are fixed, meaning that they won't rise — or fall — over time.

Are you OK with a bit of uncertainty when it comes to rates? If so, you could save significant money on interest with those low initial interest rates that come with a HELOC. You will have to take the risk that these low rates could one day rise higher than the fixed rate that you might pay on a home-equity loan.

3. How much flexibility do you need?

Home-equity loans are generally better for homeowners who need cash for a one-time event, such as paying for a child's college tuition. But HELOCs often work better when homeowners aren't quite sure how much money they'll need over time.

Say you're remodeling your kitchen, but you're not sure exactly how much that project will cost. You take out a $40,000 HELOC. If your remodel only costs $25,000, all you withdraw on that line of credit is $25,000, and that's all you have to pay back.

One of the main advantages of HELOCs is this flexibility: You only have to borrow what you need. And you don't have to know before applying for this line of credit exactly what that amount will be.

4. Can you pay it back?

Taking out a HELOC seems like an easy way to get quick access to a new line of credit. But before you take out a HELOC, make sure that you can pay back what you borrow.

Unlike a credit card, a HELOC is secured debt, which means that your creditor can take something from you if you fail to pay back what you borrow. In the case of a HELOC, the money you borrow is secured by your home. If you fail to pay back the money you borrow, your lender could begin foreclosure proceedings against you.

5. Are you spending your money wisely?

There are good and bad reasons to take out a HELOC. Paying off high-interest credit card debt is usually a smart decision because the rates on a HELOC are much lower. But homeowners do need to be careful: Again, not paying back a HELOC could result in a lost home. Creditors can't take your home if you don't pay your credit card debt on time.

Paying for major home improvements is also a good investment … usually. But tapping your equity might be a waste if you are making an improvement that won't add much value to your home. Generally, improvements such as updated kitchens and bathrooms, master-bedroom additions, and siding and roofing replacements will add value to your home. Adding a home office or in-ground swimming pool might not.

But maybe you don't plan on selling your home, and you simply want to add something that will boost your enjoyment of it. In that case, using a HELOC for home improvements that won't necessarily result in a big payoff can make sense.

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This article is from Dan Rafter of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

4 Smartest Ways to Use a Home-Equity Loan

Dan Rafter — Fri, 05 Jan 2018 09:30:10 +0000

Building equity that you can tap into for a loan is often touted as one of the main benefits of owning a home. This loan can be used to pay for everything from major home improvements to a child's college education.

But the truth is that there are good ways and bad ways to use your home's equity. There's also a big risk in doing so: Home equity loans are secured by your home. If you default on your payments, your lender can, as a last resort, take your home. That can't happen with unsecured debt such as a personal loan or credit card debt. (See also: Home Equity Loan or HELOC: Which Is Right for You?)

How should you use a home-equity loan? These are some of the best ways.

1. Fund a major home improvement

Homeowners have long used home equity loans to fund big home improvements such as kitchen remodels or master suite additions. And they can be a smart use of your home equity dollars. Just don't expect a complete return on your investment if you plan on using these improvements to help sell your home.

While a newly renovated kitchen or updated master suite can make your home more attractive to potential buyers, and could help you sell your home faster, don't expect a dollar-for-dollar increase in your sales price. If you spent $15,000 on a new kitchen, that renovation likely won't boost your home's final sales price by $15,000. Buyers will still pay what your home is worth in today's market, no matter how much you improve it.

But if you are using your renovations either for your own enjoyment or to increase the number of buyers who will be interested in your home, using a home-equity loan makes sense. Remember, though, if you plan to sell your home before you pay off your loan or line of credit, you'll have to use the profits from your home sale to not only pay off your primary mortgage, but also your loan. That will eat into the money you take away from your sale.

2. Pay off high-interest credit card debt

Borrowing from your home equity comes with far lower interest rates than credit card debt. While credit card interest rates can reach 20 percent or more, home equity loans have rates that typically fall somewhere between 4 and 5 percent, depending on the terms. It makes financial sense to take out one of the lower-rate loans and use the money to pay off credit cards.

There are caveats, though. Credit card debt is unsecured debt. If you can't afford to make your monthly payments, you won't lose your home because of it. The same isn't true of home equity loans. If you can't afford your monthly payments with these loans, you could lose your home. So only take out a home-equity loan for credit card debt if you're absolutely sure you can afford the monthly payments.

Taking out a home-equity loan doesn't make sense, either, if your credit card debt isn't that high. If your credit card debt is manageable, instead of taking out a loan, pay a bit extra each month to reduce that debt over time. (See also: 5 Ways to Pay Off High Interest Credit Card Debt)

3. A child's college education

A home-equity loan can help you pay for a child's college education. And it might be a more attractive option for parents than taking out a private loan or a federal PLUS student loan that could come with high interest rates.

Be careful, though: You don't want to sacrifice your own retirement to fund your child's college education. If taking out a loan to help your children pay tuition will make it impossible for you to save enough for your own retirement, don't take out any loan, including a home-equity loan. Your children do have options for paying for college, from taking out their own student loans to attending more affordable universities.

Your priority should be to save for your retirement. If you're on track for this and can afford to help, a home-equity loan can be a smart way to do that. (See also: Are You Ruining Your Retirement by Spoiling Your Kids?)

4. Use it to invest

If you've always wanted to invest more in the stock market, a home-equity loan can help. Say you borrow money from your equity at an interest rate of 4.25 percent, and you use these dollars to invest. If your investment yields a conservative return of 8 percent, you'll have made a solid chunk of money.

Of course, there are risks. There is never any guarantee that your investment will increase in value, and you could even realize a loss. But if you are willing to take on this risk, and you can afford a possible loss, then investing home equity dollars into the market could make you wealthier.

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This article is from Dan Rafter of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5 Ways to Build Business Credit When You're Self-Employed

Elaine Pofeldt — Tue, 07 Nov 2017 08:30:20 +0000

It's hard to beat the freedoms of being self-employed. But with the joys of being your own boss and creating your own schedule come some trade-offs. One trade-off can be unsteady income.

Even if you are very careful about your finances, it's possible that a great business opportunity will present itself that you simply don't have the cash for. If you've built good business credit and have access to a business credit card or line of credit, it will be easier to jump on those opportunities.

Building good business credit can seem like a mysterious process if you've never done it before. Here's how to get started. (See also: Best Credit Cards for Small Businesses)

1. Establish strong personal credit first

The vast majority of small business credit cards require you to personally guarantee the charges you make — even if the card is issued in your business's name. That means if the business fails, you will still be responsible for the debt.

Because you ultimately will be the one who pays the balance, expect lenders to pay attention to your personal credit when you seek business credit. Under the Fair Credit Reporting Act, when you apply for business credit, a lender has the right to look at your personal credit profile to evaluate whether to issue it to you.

To make sure you have a full array of options when it comes to business credit cards, make sure you are paying your personal cards on time and not maxing them out. A high credit utilization ratio — that is, using a large percentage of the credit available to you — can cause your credit score to drop. (See also: 5 Ways to Improve Your Credit Score Fast)

2. Run your business like a business

If you want to get business credit in the future, keep good financial records by using accounting software such as FreshBooks, QuickBooks or Xero. Using software designed for this is much easier than using spreadsheets and reduces the chance that you'll make mistakes.

Many accounting software programs have a "reports" function that allows you to create a profit and loss (P&L) statement with the click of a button. A P&L statement shows all of your sales and expenses for a set period, such as a year. To get a business line of credit with your bank, you will very likely have to produce one of these statements, so this feature is a huge timesaver. (See also: 5 Free Accounting Tools for Freelancers)

3. Keep your business finances separate

Before you try to open a line of credit with your bank or apply for business credit cards, open a business checking account. This will show lenders you are serious about running your business.

Maintaining a business checking account also gives you an opportunity to develop a relationship with your banker. If money is flowing into your account regularly, you are maintaining more than the minimum balance, and you are handling the account responsibly (i.e., the checks you write are clearing), chances are that your banker will begin to offer you products such as a business credit card and possibly a line of credit.

Don't use your business checking account to pay your personal bills. You need to establish separation between your business and personal finances and keep accurate records.

To open a business checking account, you will generally need a federal Employer Identification Number (EIN). You can apply for one online through the IRS.

4. Use your business credit card strategically

If you don't have strong personal credit, you may still be able to get a business credit card. There are some higher-interest cards designed for people with a "fair" credit score.

While paying higher interest isn't ideal, if you use the card responsibly, you'll be able to improve your credit profile and should qualify for better deals in the future.

Once you get a business credit card, use it regularly to make business purchases and pay the bill on time — ideally in full — to build a history of using it responsibly. Don't use the card for personal spending. If you connect this card to your accounting software, it will be easy to enter your business expenses, saving you a lot of time.

5. Monitor your business credit report

How do you know if you are actually building good business credit once you make these efforts? Use the free searches on Experian, Equifax, or D&B to see if your business's credit is being tracked. (You will have to pay to get the actual report).

There's a different system for business credit card scores than for personal ones. Business credit scores go from 0 or 1 to 100. Each of the major credit bureaus uses its own formula, but factors such as how long you've been in business, your credit utilization, and the lines of credit you have opened in the last six months are likely to affect your score.

If you find your business isn't on the radar screen of the major credit bureaus and you have already gotten your EIN, try applying for a free D-U-N-S number with Dun & Bradstreet, which should get the ball rolling.

All of these steps take some work and can't be done overnight, so start early — ideally a few months before you think you'll need business credit. It'll pay off. Having strong business credit is a valuable asset that you'll greatly appreciate if you ever get into a cash crunch.

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This article is from Elaine Pofeldt of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Should You Take Out a Loan Backed by Your Investments?

Carrie Kirby — Thu, 12 Oct 2017 08:30:10 +0000

If you have a taxable investment account, you may have heard from your bank or brokerage lately about the opportunity to borrow against your stock holdings. There are many attractive aspects to securities-based loans, which have gained popularity thanks to marketing campaigns. But there are also reasons to be cautious about this kind of borrowing.

Financial firms tout these loans as a convenient and affordable way to access quick cash for anything from a kitchen remodel to bridge financing for a home purchase. What they might not mention is that they have a strong incentive to get you to take out the loans; lending is seen as a good source of reliable income for brokerage firms looking to reduce their reliance on commissions.

Securities-based loans (also known in the industry as non-purpose loans and securities-based lines of credit or SBLOCs) have risks, which led the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) to issue a consumer warning about them.

The benefits of securities-based loans

It's not as if your broker is lying if they tell you that taking out a securities-based loan can be a good way to get liquidity when you need it. There are real benefits.

1. Low rates

Brokerage firms have been issuing securities-based loans at rates lower than what you'd pay on a personal loan or credit card balance, and competitive with or better than what you'd pay for a home equity line of credit.

2. Lenient application process

In a 2015 investor alert, the Securities and Exchange Commission noted that "some SBLOC lenders might not run a credit check or conduct an analysis of your liabilities before setting and extending the credit line." Since the lender has your stock as collateral, they don't need to worry too much about whether you can pay back the loan.

3. Fast turnaround

Funds are typically available less than a week after applying. This speed can be clutch if, say, you are in a competitive bidding situation for a house and want to have a down payment and earnest money ready at the drop of a hat.

4. Keeping your stock (and avoiding taxes)

Of course, if you have stock and you need cash, you could simply sell the stock to pay for what you want to buy. One reason some investors prefer to borrow against their portfolio value is the potential tax advantage: By keeping the stock, they avoid registering a capital gain, which they'd have to pay tax on that year. This benefit may be particularly valued by retired people who hope to hold onto their stock for life and pass it on to their heirs, since the cost basis will be stepped up to the market value at the time of death. This means that any new capital gains will be based on the price of the stocks when they were transferred to an heir, and not the price when they were first purchased.

Another situation when avoiding selling stock might really come in handy: If you bought the stock within the past year and want to wait a year before selling it to qualify for the long-term capital gains rate, which is lower than the short-term rate. (The short-term rate is the exact same rate as your ordinary income.)

Finally, keeping your stock means retaining the benefits of ownership, including any dividends, voting rights, and potential future gains.

The risks of securities-based loans

With all those pluses, why did the SEC and FINRA warn us about this kind of loan? Because they come with risks that may not be immediately apparent to the borrower.

1. The maintenance call

If you buy a house and the housing market crashes, you may end up owing more than the house is worth; but at least you can keep your home as long as you can make the payments. Not so with securities-based loans.

"SBLOCs are classified as demand loans, which means lenders may call the loan at any time," the SEC warns. Typically, this would happen if the market goes down and the value of the securities you're borrowing against decreases sharply; the lender would make what's known as a "maintenance call," demanding that you pay all or part of the loan. If you can't, the lender will sell your stock at the current price. If this happens, you'd basically be forced to sell at the worst possible time.

What are the odds of this happening? No one can see the future, but the current bull market is considered downright elderly at eight years old, leading many experts to predict a correction or recession sometime soonish. It would be foolish to expect the value of your portfolio to always rise and never fall.

2. Variable interest rates

As with any loan, read the fine print before signing on the dotted line. Many securities-based loans charge variable interest rates, meaning that you will never know how much your interest expenses will be each month.

3. Unexpected tax bill

If you bought a stock at a low price, borrow against it at a higher price, and it dips to a price between those two prices, it could spell tax trouble. If the lender forces a sale to pay the loan, you'll owe capital gains tax on the difference between your purchase price and the sale price — which could really sting if the sale proceeds went to pay off the loan, leaving you with no cash.

4. Lost freedom

The SEC warns that you will likely have to pay off any securities-backed loans before moving your assets to another brokerage firm — which could be another reason that brokerages are pushing these loans.

So should you get a securities-based loan?

While your broker's suggestion that you get a securities-based loan might be laden with self-interest, that doesn't mean you have to say no. Weigh the pros and cons before deciding, and consider taking these measures to safeguard the process if you go ahead.

1. Borrow less than you qualify for

Lenders are offering clients loans worth as much as 95 percent of an investment portfolio. The lower the percentage of leverage, the safer you are against the risks of securities-based borrowing.

2. Borrow only against a diverse portfolio

If you only own stocks in the energy sector, it won't take an overall downturn to cause a securities-based loan disaster; a sharp downturn to that one sector could do it. Investing in diverse sectors is always a good idea, but even more so if you're borrowing against your holdings.

3. Have a maintenance call plan

If you can put up the additional funds the lender demands in a maintenance call, you won't be forced to liquidate your shares at an inopportune time. So figure out in advance other ways to meet that maintenance call, whether it's tapping an emergency fund, borrowing from family, or liquidating other assets.

4. Don't borrow to pay for something without resale value

The marketing materials brokerages use to encourage securities-based loans mention vacations. But if your loan gets called in, you can't sell your vacation memories to raise the necessary cash.

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This article is from Carrie Kirby of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Credit Challenged? How Alternative Credit Data Can Help Those With Little or No Credit

Yasmin Ghahremani — Tue, 10 Oct 2017 09:00:06 +0000

If you've got no credit file, or a very thin one, you know how hard it can be to get a credit card or loan. Without a credit record, you can't get a credit score, and lenders can't easily judge how much of a credit risk you are.

Don't give up. Lenders are slowly beginning to consider other kinds of information when making credit decisions. That may help you get approved for credit, even without a traditional credit score. But it's important to also understand how this so-called alternative data is used, and the implications for your privacy.

What is alternative data?

Traditional credit data relies on information about how you've used credit or debt in the past. It is compiled by the three major credit bureaus: Equifax, Experian, and TransUnion. That data is then used by the major scoring companies, FICO and VantageScore, to build your credit scores. (See also: How to Read a Credit Report)

Maybe you haven't had experience with credit, or you had a negative experience that doesn't tell the whole story of how you would behave now with a new loan. Alternative data providers look at how reliably you've paid rent, utility bills, or rent-to-own agreements. They dig up nonpayment information, too.

For instance, LexisNexis Risk Solutions gathers publicly available documents that show your professional licenses, evidence of college attendance, ownership of assets such as a home or boat, felony convictions, and your address stability. "Address stability is the concept that if you're living in the same address for a period of time, you're more stable than if you're bouncing around four times a year," says Ankush Tewari, senior director of credit risk assessment at LexisNexis Risk Solutions. "Multiple client studies have shown that people who move frequently are riskier than people who have a stable address history."

LexisNexis Risk Solutions says the data it collects all has some proven ability to predict creditworthiness. By adding this sort of data to regular credit bureau data, it can help score about 40 million consumers who don't have a regular credit score. The company has paired with FICO and credit bureau Equifax to create an alternative credit score called the FICO Score XD. It's only for people whose credit files are so thin they can't get a regular credit score, and it relies on payment data from a consumer's utility, phone, and other bills.

According to FICO, the new score should allow lenders to score more than half of all previously unscorable applicants. It's found that more than a third of those people turn out to have a FICO Score XD of at least 620, the cutoff point many lenders use for even considering a credit application. That means more people should be getting approved for credit. The trouble is, the product is so new, FICO has not revealed how many lenders are using it.

TransUnion has had a similar scoring model called CreditVision Link since 2015, which incorporates a trended look at traditional credit data (how you've performed over time) with non-credit-related data collected from consumers' banking accounts, payday lending histories, and property, deed, and tax records. TransUnion told The New York Times that about 100 companies — primarily auto lenders and online lenders, but also an increasing number of credit card issuers — are using or testing the score. They're usually able to approve about 20 percent more applicants than they could before.

How alternative data can help you

The driving force behind the use of alternative data is lenders' desire to reach new customers who are creditworthy but can't show it through traditional means. "Lenders tell us, 'We don't need help declining more people. We need help growing our business but without increasing our credit risk,'" says LexisNexis's Tewari.

That should mean good news for consumers who have been responsible with their finances but who haven't had a chance to build credit or have stumbled along the way. Alternative data may help increase your chances of being approved for a loan or credit card. "It allows consumers to show that, while they may not be in a position to get a mortgage or a car payment, or they have no desire to get a credit card, they are still taking care of everyday financial responsibilities," says Kim Cole, community engagement manager for Navicore Solutions, a nonprofit credit counseling agency in Manalapin, New Jersey.

A new company called FS Card is using alternative data to offer a credit card called Build Card to people who would otherwise have been rejected for a credit card. Build Card's target market is consumers with credit scores of 620 or below, meaning their credit is considered subprime. In the past, the only kind of card these consumers probably would have been able to get is a secured card, which requires a deposit of several hundred dollars upfront.

Build Card asks applicants to agree to let the company use alternative data to assess their risk. In addition to traditional credit data, Build Card looks at payday loan information to determine whether an applicant is creditworthy. "We're looking for an inflection point that shows the consumer has changed and is able to take on regular credit," says Marla Blow, CEO of FS Card. Typically this means they've been able to close out a payday loan. "We're looking at the top 15–20 percent of payday loan users," she says.

If the applicant is approved, they'll be given a regular credit card — no security deposit required. Granted, there is a $53 upfront fee, APRs are 25–29 percent, and the initial credit limit is only $500. But it's a step up from a payday loan. And if you do well with the initial credit limit, you can eventually have it increased to $750.

Concerns about privacy and transparency

One of the biggest concerns with alternative data is that people don't know it's being collected and used. Not everyone wants their financial history and other information rounded up and made available to financial institutions. And, as with any organization that collects personal information, there is always the chance that a data breach could happen. It's one thing if information that was already publicly available is stolen, but it may be more worrisome if you've voluntarily shared payment information that then gets disclosed in a breach.

Beyond privacy and security, there are concerns about transparency. If you don't know what information lenders might look at when they're making lending decisions, you can't shape your behavior appropriately. For instance, maybe if you knew that bank overdrafts not only cost you money, but could also cause a lender to frown on your credit card application someday, you would be even more careful about not overdrawing. That's why some consumer advocates say you should first be asked whether you want to opt in to the collection and use of this sort of data.

Consumer groups also worry about the accessibility of information that's being collected. "People need to have access to data collected about them," says Linda Sherry, director of national priorities at Consumer Action. "They need to be able to verify that it's accurate and to put notes on it to say what's happened in their life to justify why these things are happening to them."

You already have those rights when it comes to data on your traditional credit report. The Fair Credit Reporting Act (FCRA) gives you the right to access your credit reports and if you find an error, it says the credit bureau must investigate and so must the bank or credit card issuer who furnished the data. The FCRA also requires creditors and employers to notify you if they've rejected you based on information in your credit report. That way, you can check the information and dispute it if it's incorrect.

LexisNexis says you also have those same rights with the alternative data it collects. If you are, say, turned down for a loan because you've got a lien or judgment, you should be notified of that and given the chance to dispute any inaccuracies in the reporting. "Alternative data must be compliant with the FCRA, which requires consumers have access to data that's used in credit decisions," says Tewari, who adds that his company allows consumers unlimited free access to the data it has on file. You can request it at any time, and as many times as you like. "They have the ability to review it and correct it if there's an error," he says.

What you can do

While data collectors and lenders are in the driver's seat when it comes to the use of alternative data, there are still some things you can do to build your credit.

1. Pay all of your bills on time

This is always important, but even more so in times when companies are collecting information about how you pay all kinds of bills. Keeping on top of payments could help you build credit that you'll need in the future. Avoid overdrafts on your checking account, too, as this is a costly behavior that could also mar your alternative credit profile.

2. Check your traditional credit report and dispute any errors

"If someone has been denied by the big lenders, that's a wake-up call that they need to go into their credit report, figure out why they're being denied, clean up the credit report as much as they can, and get back on track with a good credit history," says Consumer Action's Sherry. "That's the best way to show yourself as someone that lenders will trust."

3. Get a secured card

This is the traditional way to go, and it works. Save up $300, use it as a deposit on a secured credit card, get a $300 credit line, then only make a small purchase with it a few times a year. At the end of a year — maybe sooner — you should have built enough credit to get a regular credit card. (See also: The Best Secured Credit Cards)

4. Ask your lender to look at FICO Score XD

Since this scoring model is fairly new, you likely won't see any immediate results if you request a lender review it. Banks have to pay to get access to this scoring model. But eventually if lenders see enough demand from consumers, they will begin to adopt it. It certainly can't hurt to ask.

5. Consider providing your own alternative data

If you're applying for a loan, it may help to present letters of good standing from your landlord, utility providers, or other monthly services that you pay on time.

6. Don't worry — yet — about modifying your behavior to fit the FICO Score XD model

For instance, if you really need to change addresses for the second time in a year, don't hold back just because it might affect your alternative credit score. A whole host of factors goes into most lenders' credit decisions, so no one factor is given too much weight.

7. Monitor your alternative credit record

This is not as easy as monitoring your traditional credit record, but if you're interested you can find out who's collecting your financial details by consulting the Consumer Financial Protection Bureau's list of 42 consumer reporting companies. You'll have to check with each company's website to find out how to get your free annual report.

8. Correct mistakes if they arise

If you get a note that you've been denied credit due to a piece of alternative data, ask who furnished the information, and make sure it's accurate. You have the same right to dispute errors in alternative data as you do with traditional information on your credit report.

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This article is from Yasmin Ghahremani of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

My 2016 Budget Challenge: How to Decide When to Sell Your House

Max Wong — Fri, 14 Oct 2016 10:00:06 +0000

[Editor's Note: This is the latest episode in Max Wong's journey to find an extra $31,000 this year. Read the whole series here.]

Mr. Spendypants and I have been struggling to improve our finances by reorganizing our debt, specifically the loans on our two houses. Because banks use a stricter set of guidelines for assessing risk for rental properties, it has proved impossible for me to restructure the mortgage on my rental property that I own in my own name. So, at the beginning of the summer, we set our sights on refinancing our primary residence that is in Mr. Spendypants' name.

We've Been Underwater on Our Mortgage for Almost a Decade

Here's the back story: Mr. Spendypants bought Dinky Manor for $585,000 in 2007, literally the week before the housing market tanked. He hadn't even moved in when he discovered that the property was now underwater. We have been patiently waiting for the market to recover for nine years.

The real estate market in our neighborhood is now crazy. People are buying 400 square foot homes for $400,000 in cash, sight unseen. So, we thought, now is the time to jump at getting a better loan. Zillow appraises our house for over $740,000.

Those Two Times We Missed the Days of Sub-Prime Lending

In order to refinance, Dinky Manor has to appraise for $640,000. Alas, Zillow's appraisal of our house is wildly optimistic. Our mortgage broker had two separate appraisals done and both came in at $600,000. Although Dinky Manor measures in at just a smidgen over 1,000 square feet, we're not even the smallest house on the block. Also, our yard is large and gorgeous and has been featured in garden books and on the Sunset Magazine blog. How, in L.A.'s stupid expensive real estate market, are we missing the mark?

Some of My Best Ideas Are Really Dumb

In trying to figure out another way to lower our mortgage costs, I had a harebrained idea: I could sell my rental property, that has at least $600,000 in equity, and use the profit to buy Dinky Manor from Mr. Spendypants. We'd lose my future income generating property, but we'd end up owning Dinky Manor free and clear. Without a mortgage payment on either house, we could really start socking away the cash for early retirement.

I called my accountant/therapist to get her blessing. "That is a harebrained idea for a couple of reasons," she stated, flatly. "You guys should come into my office for a financial tuneup."

When we arrived at my accountant's office she delivered the bad news: If I sell my rental house, I will have to pay between $200,000 to $300,000 in capital gains taxes. Also, even though my name is not on Dinky Manor's deed, I would not be able to buy it from my husband since we file our taxes as a married couple, so in the eyes of the IRS it's my house too.

This is why I will never be successful as a master criminal. All the good financial loopholes have already been taken.

When Faced With a Financial Decision, Do the Math

My accountant had another scenario to pitch us: Sell Dinky Manor and move into my rental property as our primary residence. Even if we take a financial hit on the sale of Dinky Manor, the loan on my rental is half that of Dinky Manor. If we continue to live frugally like we've been living this year for My 2016 Budget Challenge, we could pay off my house in six years.

Another bonus of this plan: If I sell my rental property, I have to pay capital gains taxes. But in California, when you sell your primary residence, you don't have to pay capital gains on the first $500,000. So, if I move back into my rental house and use it as my primary residence for 24 months, I could then sell it and walk away with a $500,000+ profit.

Mr. Spendypants was shocked by this idea. He had hoped that we could wait out the housing market and flip Dinky Manor for a profit. But when my accountant did the math for him, he realized that we could be debt free and own a house outright in as little as six years, an impossible goal if we keep both houses. While the prospect of financial sustainability in six years is thrilling, the disappointment of only breaking even or even losing money on the sale of Dinky Manor hurt his brain.

How Do We Add Value to Our House?

I called my friend Andrew, a real estate agent who specializes in our neighborhood, and explained our situation. He agreed with our accountant's plan to sell Dinky Manor. Even if we lost money on the Dinky Manor sale, the amount we'd save by paying down the mortgage on my house early would more than offset that. Although we probably won't be able to buy another house, ever again, in L.A.'s inflated market, if we wanted another rental property down the road, we could use the equity in my house to buy property in another area.

I asked Andrew if I could hire him to come over and do his own audit of Dinky Manor. Zillow values Dinky Manor at over $740,000. Why did our appraisals come up so short? If we couldn't get our house value up enough for a re-Fi, how would we ever get the value up enough to get the $60,000 down payment back if we sell it?

Andrew spent over two hours looking at our house and yard. He also brought over some comps of similar homes that had sold in a one-mile radius of our house. His assessment: Dinky Manor is a dump. (Yes. Only in Los Angeles can a 1,000 square foot dump appraise for only $600,000). The appraisers had negatively compared our 1937 bungalow as a fixer-upper to new homes with Ikea kitchen cabinets and freshly installed privacy fencing. He gave me an extensive To Do list of home projects that would improve the house's value. If we fixed everything on his list, he would be able to put the house on the market with a starting price of $699,000.

In order to get to this $699,000 price, we are going to have to repaint the house, build a deck, and do a complete redo of the kitchen, bathroom, and roof. This will cost between $40,000 and $60,000 depending on how lucky we get with sourcing the building materials. The renovation will be much more efficient and less stressful if we are not living in a house without a working kitchen and bathroom. If we empty out Dinky Manor before construction, we could possibly finish all the projects on the To Do list in one month (but I'm scheduling for two months).

It's only October, and already I have My 2017 Budget Challenge in place. If we want to be mortgage free ASAP then here's our agenda for the next year:

Save up at least six months of living expenses, because we will have to carry the mortgage of both homes during this process.
Give my amazing renters, who have lovingly cared for my house for the past five years, 90 days notice so they have ample time to find a new pad.
Move into my house the second the renters move out.
Because we don't have the savings to pay for the renovations and pay two mortgages simultaneously, we will have to take out a $60,000 Home Equity Line of Credit on my house (based on its insane amount of equity).
Renovate Dinky Manor.
Put Dinky Manor on the Market.
Sell Dinky Manor. If there is any profit at all (fingers crossed) from the sale, it will be used to pay down the Home Equity Line of Credit.
Refinance my house (now our primary residence) to get a better interest rate.
Aggressively work toward paying down the Home Equity Line of Credit and the mortgage of our one house.

Looking at this list of things to accomplish is heart attack inducing. And, if it were up to only me, I'd probably have Andrew sell Dinky Manor as-is and eat the cost of the down payment just to avoid a year's worth of hassle and stress. But, Dinky Manor is Mr. Spendypants' asset, so he ultimately gets to call the shots on this one. This is financially risky. Worst-case scenario, we could lose $120,000 and a year of our life to this project. Best-case scenario, we could make $200,000 and lose a year of our life to this project. Either way, we will no longer have a $585,000 loan to pay down. We might lose a real estate battle, but could still win the war.

A few days after giving me his advice (for free), Andrew called me with a job offer. He just started his own boutique real estate brokerage. Would I be interested in working a few hours a week, helping him set up his new company? Of course I said yes. Now I am getting paid to learn about real estate so I can be that much more prepared when it comes time to sell Dinky Manor.

Progress So Far

My mechanic just called me. "I have good news and bad news to tell you," he said in that Swedish accent that sounds like lingonberry jam smells. "The good news is that you passed your smog test. The bad news is that you can drive your car for another two years."

Ha ha.

Even though Mr. Spendypants earned an extra $800 this month DJing a party, the car repairs involved in getting my car to pass the smog test cost $700. So at the end of the month, he only came out $100 ahead on additional earnings. Boo.

I made $375 this month working for Andrew, $450 for writing, and $630 selling jam and honey at a local craft and food fair for a total of $1,455 extra.

Even with the additional earnings, as of today we have only have $10,741.51 in our savings account out of the $31,000 that we want to have by the end of the year.

Will we make our goal?

Goal: $31,000

Amount Raised: $23,595.17

Amount Spent: $12,853.66

Amount Left to Go: $20,258.49

This article is from Max Wong of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

7 Investment Accounts All 30-Somethings Should Have

Tim Lemke — Thu, 03 Mar 2016 10:30:34 +0000

You're in your 30s now. If you're finally looking to get settled in your financial life, you may want to consider ways to build wealth over the long term. But that checking account alone isn't gonna cut it. It's time to examine the options out there for someone in their 30s who finally has a little bit of money to invest.

Here are seven essential investment accounts all 30-somethings should have.

1. 401K, If Available to You

If you're employed full-time, your company may offer a retirement plan that gives you access to a number of mutual funds and other investments, plus the great tax advantages that come with it. Under a 401K, 403B, or similar plan, contributions are deducted from your pre-tax income, and most employers will match a certain percentage of what you put in. Now that fewer employers are offering pensions, the 401K has become the primary vehicle for saving for retirement. Pumping cash into this account while you're still relatively young gives your investments plenty of time to rise in value and give you a sizable nest egg. Even better, your investment is tax-deferred until you begin making withdrawals.

2. Traditional IRA

You don't necessarily need a traditional Individual Retirement Account if you have a 401K with an employer match. But if you have 401K from an old employer, it might make sense to roll it into an IRA, because you have a much broader choice of investments to choose from — many with lower fees. With an IRA, you can invest in practically anything, including individual stocks, mutual funds, bonds, and even commodities. Traditional IRAs are also great for people who are self-employed or otherwise don't have access to a 401K. Like a 401K, your contributions are deducted from your taxable income. You can open an IRA at most discount brokers such as Fidelity, TD Ameritrade, and E*TRADE.

3. Roth IRA

This account is a little bit like a 401K in reverse. The tax advantage is on the back end, when you can withdraw money upon retirement without paying tax on the earnings. That's because contributions to a Roth IRA come from earnings after tax, unlike 401Ks, which draw on pre-tax income. Under a Roth IRA, you can contribute up to $5,500 annually, and you can withdraw contributions (but not your gains) before retirement age without paying a penalty.

4. Taxable Brokerage Account

While your main focus should be investing in tax-advantaged accounts that are designed for retirement, it's good to have some investments available in this type of account due to the flexibility. You don't need to wait until retirement age to access funds in this account, for one thing. That means you can use it to boost your income now, through the sale of stock or the gain of dividends. If you hold on to investments in a taxable account for a long time (generally over a year), you'll pay only the long-term capital gains tax (mostly likely 15%) when you sell.

5. 529 College Savings Plan (If You Have Kids)

College is pricey, so nearly every state enables people to save for college by investing money for education in a tax-advantaged way. A 529 plan is similar to a Roth IRA, in that investments will grow tax-free until they're withdrawn, as long as they are spent on higher education. In many states, you also get a tax break from the contributions. It's possible to open a 529 for your child as soon as they have a social security number. Even if you don't have kids yet, you can designate a beneficiary now — such as a niece or nephew — and change it to your own child later. (See also: The 9 Best State 529 College Savings Plans)

6. High-Interest Savings Account

Everyone knows you need a basic bank account, but if you want to boost your savings, it's helpful to have a savings account with a higher-than-average interest rate. These days, interest rates are extremely low, but you can still find returns of above 1% in money market accounts and online banks. (See also: Best Online Checking Accounts)

7. Peer-to-Peer Lending Account

In addition to making it easier to invest in stocks, the Internet age has also made it possible for individuals to invest in other people's debt. There are thousands of people who have hopped onto sites such as Lending Club and Prosper and report consistently solid returns. These sites generally work in the same way as banks, except that those in need of money are borrowing from individuals, who are seeking to make money on the interest. In most cases, people can invest based on the risk level of each borrower; those who aren't as creditworthy promise a potentially higher return — but more risk — to the investor. Popular personal finance blogger Mr. Money Moustache has reported more than an 11% annualized return since 2012, and many others report similar gains. (See also: How to Make Money with Prosper)

How many of these accounts do you have?

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This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

10 Terrible Loans You Should Avoid

Carrie Kirby — Mon, 23 Mar 2015 13:00:03 +0000

We've all been taught that most types of debt are bad news. But some loans are such egregiously awful financial instruments, we think they deserve special mention.

Below are 10 of the worst loan options available. You'll find they feature many things in common, such as exorbitant interest rates or various enticements to make you spend and borrow more. These loans so bad, you should only consider them as an absolute last resort.

1. The Payday Loan

Payday lenders present themselves as a friendly, helpful, and practical solution to running out of money before the end of the month. You've seen the claims on storefronts, and you've probably heard the commercials by now: "Money as soon as tomorrow!"

What payday lenders really are, according to Senator Elizabeth Warren, are "a credit product that can impose substantial costs on imperfectly informed and imperfectly rational borrowers."

Warren decried payday lenders or cash advance companies in a paper "Making Credit Safer," which noted that a typical $30 fee on a $200 loan amounted to a nearly 400% annual interest rate. These companies make 90% of their profit on customers who roll their loans over, paying again and again for the money they've borrowed.

The Consumer Federation of America is so concerned about the long-term debt cycle which frequently traps borrowers, that they set up a web site to warn potential consumers of the risks of payday loans. (See also: Confessions of a Former Payday Loan Junkie)

2. The Car Title Loan

Car title loans are a notoriously awful option. The deal is, you borrow money at a high interest rate (typically 300%), and the loan is usually due in full in 30 days. As security, you sign over the title to a paid-for vehicle. That's a very bad idea, says the Consumer Federation of America.

"Car title lending risks repossession of major family asset," the organization warned in a paper that cited the forfeiture of thousands of vehicles in various states through these loans. The loan amount is generally a fraction of the car's market value.

3. The Tax Preparer Loan

Because of a regulatory crackdown, the big tax services have quit offering classic refund anticipation loans, where they would give you the money the IRS owes you weeks ahead of time in exchange for a hefty cut. But some of those same companies are now offering personal lines of credit with double-digit interest rates and a swarm of fees. Steer clear.

4. The Credit Card Cash Advance

Credit card cash advances seem appealing because you already have a relationship with your credit card, so there's no paperwork to fill out; they're instant, and there are no embarrassing face-to-face conversations involved. You've probably even gotten those "convenience checks" along with your credit card bill, or seen the logo of your credit card network on an automated teller machine.

Those perks come at a steep price: high fees and interest. The average fee is $10-$20, and the interest rate you'll pay ranges from 1% to 7% above your credit card rate. The only time you should even consider taking a cash advance is if your car breaks down out of town and the mechanic won't take a credit card.

"It ought to be a last resort," David Jones, president of the Association of Independent Credit Card Counseling Agencies, told CreditCards.com.

5. The Casino Loan

Many casinos offer interest-free, fee-free lines of credit that can only be used to gamble. The only reason you should ever take advantage of such an offer is if you have the cash in your checking account and you prefer not to carry it.

"Never borrow money while gambling. Chances are good that you'll lose it, making a bad situation even worse," advises part of the "Casino Gambling for Dummies" Cheat Sheet.

Like other lenders, casinos generally have the ability to put a lien on your home if you don't pay, setting the stage for a bad day at the tables to spin into a very bad year — or even a terrible decade.

6. The Installment Loan

Similar to the payday loan, the installment loan gives the borrower a small amount of money — often $1,000 — on short notice at a high interest rate. But unlike payday loans, which are often due in full in just a few weeks, installment loans can be stretched over six months or a year. These loans have skirted some of the scrutiny regulators put on payday lenders, but have landed consumers in much the same trouble. Take Naya Burks of St. Louis, who ended up having $5,300 taken from her paychecks after she defaulted on a $1,000 installment loan from AmeriCash. Those payments did nothing to chip away at the loan balance, which instead grew week by week because of the 240% interest rate, eventually ballooning into a $40,000 debt.

7. The Private Student Loan

Student loans may be a fact of life for many scholars nowadays, but think hard before turning to a private lender instead of federal programs.

"While federal student loans offer options to avoid default through several loan modification and alternative repayment programs, lenders and servicers of private student loans generally do not," the Consumer Financial Protection Bureau warned in its annual student loan report. Private student lenders may also prevent you from selectively paying off higher-rate loans first, complained the blog Money Ning.

8. The Pawnshop Loan

If you live in a big city, you've probably passed pawn shops, which take jewelry, cameras, and other personal property as loan collateral, and keep the goods if the loan isn't paid in time. The New York City Department of Consumer Affairs warns that in addition to charging high interest rates, these shops often charge service and storage fees, driving the true interest rate sky-high. Many people end up paying more than the market value of their property to the pawnbroker, but can't pay all they owe and end up losing the property, anyway.

9. The Overdraft Loan

Your bank may have encouraged you to opt in to "overdraft protection," a program that allows you to write a check or withdraw funds from an ATM even if you have no money in your checking account. Tim Chen, CEO of NerdWallet, says you should never do this.

When your bank provides this "protection," it charges you a fee — about $35 — for that transaction and every other transaction on your account until the balance is above $0. In the end, you could end up paying even higher rates for that overdraft loan than you would borrowing from a payday lender, Chen warns.

10. The Lotto Winner Loan

Most of us will never be in the position to be victimized by this kind of loan, but if you ever win the lottery, watch out. The public radio program This American Life explained that these lenders go after people who have won jackpots to be paid out gradually over the years. They buy the winnings for an upfront payment, often pressuring the winners to sign off on a sum that is just a fraction of their winnings. Fortunately, now that most states offer a lump sum option, these lenders are no longer prevalent.

Have you ever used one of the loan products mentioned above? Why or why not?

This article is from Carrie Kirby of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Stop! Is That Loan Too Big For Your Wallet?

Tim Lemke — Fri, 06 Mar 2015 16:00:06 +0000

It's not uncommon to find yourself in need of a loan to pay for a home, car, or other major expense. But navigating the world of lending can be a bit bewildering.

If you're careful and sensible, it's possible to borrow money without risking your financial wellbeing. In fact, responsible borrowing can be an integral part of wealth-building. The key is to know how much loan you can actually handle easily. But, how do you determine this?

1. Know Your Credit Score

Your FICO credit score will play an enormous role in the size of the loan you can qualify for and the interest rate that you will pay. The higher the score, the better off you'll be. Everyone is entitled to one free credit report each year, so be sure to examine it if you're considering taking out a loan. A credit score above 720 usually qualifies you for good rates. Anything less than that, and you may want to consider taking steps to improve your score before borrowing. This means correcting any errors and paying down outstanding debts.

2. Learn About Debt-to-Income Ratios

The general rule of thumb regarding mortgage loans is to avoid dedicating more than 28% of your monthly take-home income to housing. This includes not just the mortgage payments, but also related taxes and fees, which can add another 2%-3% to the overall cost. So in other words, a person taking home $50,000 should avoid paying more than $1,166 per month toward their home. ($50,000 x 0.28 = about $1,166)

There's another key factor, however, and that is your overall debt load. The 28% rule above applies to the mortgage loan itself, but financial experts advise having an overall debt-to-income ratio of no more than 36%. So if you already have other loans, you may want to take on a smaller mortgage, or paying them down before borrowing more.

3. What You're Approved For Is Not Necessarily What You Should Borrow

When you apply for a loan, a lender will usually let you know how much you are approved to borrow. It's best to ignore that number. Just because you are approved to borrow $500,000 for a home does not mean it's wise to go and borrow $500,000. It's nice to get approval, but banks found themselves in trouble a few years ago when they approved loans for amounts that were well beyond what the borrowers could comfortably afford.

4. Down Payments Are Key

If you can't afford to buy a house or other big purchase in cash, at least put down as much money as you can. This will reduce the size of the loan and the amount of interest you will pay. A larger down payment could also make you more attractive to lenders, who can offer a more generous interest rate. When buying a home, a down payment of 20% or more will usually mean you can avoid paying for mortgage insurance.

5. Look at Loan Length, Not Just Monthly Payments

All too often, borrowers will focus on the monthly payments without looking at the total cost of a loan. The great car buying advice site, Edmunds, advises to keep loan terms under five years, and reports that two additional years on a loan of a Honda Accord would add more than $3,400 in interest charges. Similarly, a 15-year mortgage on a home will save you tens of thousands of dollars over a 30-year term, even if your monthly payments are higher.

6. Future Income Is Not Guaranteed

I once heard a friend say that they planned to purchase a more expensive home than they could really afford, because they figured they'd be earning more down the road. This is a very risky approach to borrowing. A more sensible approach is to borrow based on your current financial situation, then any extra income you earn over time can go into savings or be used to pay off the debt earlier.

7. Don't Steal From Your Future Self

Are you putting away money toward retirement? Would a mortgage payment or other loan prevent you from contributing to an IRA or 401(k)? If you're making loan payments but are unable to set aside money for the future, then you may be borrowing too much. Set aside 10%-15% of your salary for retirement before seriously considering large loans.

8. Consider Future Expenses

A couple with no children might crunch some numbers and determine that they can comfortably afford a loan of a certain size, but will their monthly expenses always be what they are now? It's important when borrowing to try and anticipate future costs, especially when exploring a long-term loan. A good rule of thumb is to assume that your costs will rise yearly with inflation (roughly 2%-3% a year; add more if you expect a larger family, or a move to a more expensive area).

What rules of thumb do you use to know your loan limits?

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This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

What the New Credit Card Formula Means for Your Wallet

Tim Lemke — Mon, 22 Dec 2014 14:00:11 +0000

FICO, the company that provides information to the three major credit bureaus, has made changes that could potentially lead to higher credit scores for millions of Americans.

The changes announced in August from Fair Isaac (FICO) could help those dealing with medical debt, and will also give a boost to people who were dinged with collections but paid off the related debts.

Here's a look at what the changes mean for you.

Medical Bills Won't Hurt You as Much

FICO said that if you are someone whose only negative references are for medical collections, your score will rise an average of 25 points. FICO said it will use a "more sophisticated treatment" to determine the difference between medical and non-medical collections. In essence, FICO learned that many borrowers have medical debt, but that it's not necessarily an indicator that they won't pay back other monies owed. Critics of previous rules said penalizing people for medical debt was unfair, because patients often don't know what they owe hospitals and doctors and high medical fees combined with limited insurance coverage can be catastrophic to people's budgets.

Collections Won't Be Viewed Badly, as Long as You Eventually Paid

Under previous rules, borrowers saw their credit scores go down if there was any record of a collection — even if they eventually paid the debt off in full. In fact, those collections stayed on a person's record as long as seven years, even if they had no other unpaid debts. Now, getting a visit from a collection agency won't hurt you, as long as you pay whatever was owed. The Wall Street Journal reports that about one in ten people who had a collection now have no balance at all. (See also: Best Secured Credit Cards to Rebuild Credit)

Borrowing Should Be Easier

In general, these changes should cause credit scores to go up for most people. That means more people could qualify for loans and credit cards, and those who could already borrow will now get access to lower interest rates. But be careful: Just because you're eligible to borrow more money doesn't mean it's necessarily wise to do so.

In an interview with the Wall Street Journal, one lawyer specializing in consumer protection warned of the possible negative consequences.

"A lot of people really just can't handle credit — you're not really helping them by allowing them to dig themselves into debt," Howard Strong, a lawyer in Tarzana, California, told the newspaper. "It's like a sharp knife — if you don't know how to use it, you can cut yourself."

For Those With a Thin Credit History, It Could Go Either Way

If you're just starting to build your credit, you have what FICO refers to as a "thin file." Previously, those with "thin files" were judged in absolute terms — you either paid your bills or you didn't. Now, FICO has the ability to analyze new borrowers in a more nuanced way. Depending on your payment history, this could improve your score or cause it to go down. If you've been great about paying your bills, even if you have a thin file, you'll probably be unaffected. On the flipside, you probably won't see your score improve if you've missed a lot of payments. It's those folks in the middle that may see an adjustment.

It May Not Impact Anything Right Away

FICO is hoping all three credit bureaus adopt the new scores this year. But it will take some time for lenders to adjust their policies. FICO said it will begin educating lenders now in the hopes they will be on board with the changes later in 2015.

It's Still up to the Lender

The FICO Score 9 is not the only score that lenders can look at. The Wall Street Journal reported that there are about 45 different kinds of scores that lenders can look at, depending on the type of loan a borrower may be seeking. And even if they do look at the new FICO score and like what they see, they might still deny your loan for other reasons.

None of This Matters If You're Awesome

These changes to FICO scores could have an enormous positive impact for those with debt. But if you use credit responsibly by paying bills in full and on time, you probably already have great credit and won't notice much of a change.

Do you expect the new FICO formula to change your credit score? Or are you already awesome?

This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

7 Ways to Boost Your Finances While You Sleep

Tim Lemke — Mon, 15 Dec 2014 14:00:07 +0000

So you work from 9-to-5, but your income just isn't cutting it. You need to earn more money, but there are only so many hours in the day. Your problem could be solved with passive income, or money you can earn without needing to be physically present — even in your sleep. (See also: 12 Side Jobs for Stay-at-Home Moms and Dads)

Check out these strategies for increasing and diversifying your income without having to take on another "real" job.

1. Sell Products Online

It's easy to setup an ecommerce store for selling products online, or you can partner with a big company like Amazon to do the selling for you. Selling items on auction sites like eBay is also easy. Even monetizing your hobbies via sites like Etsy can pay off big time. There is no need for you to be present — or even awake — to receive orders or payments.

2. Create Awesome Online Content

It's definitely possible to make money while blogging or producing YouTube videos, especially if you're consistently producing awesome stuff. Of course, scientists have yet to discover a way to blog while sleeping. So, the work itself has to happen with your eyes wide open. But the money-making part of the operation can happen while you're sound asleep.

People can read your content at any hour and click on your site's advertisements. You can also make money through affiliate marketing, in which users click on a link to a product or service, and you get a cut from any sale. It's possible to schedule social media updates to direct people to your site at any hour. Waking up to see a robust new traffic and revenue report can be a truly exhilarating experience.

3. Rent a Property

Being a landlord can often be more difficult than people expect, but it can be a great passive income stream if you have a low-maintenance property and great tenants. Ideally, the amount of rent you collect will exceed whatever payments you have to make on the property, making it a profitable venture that you can manage on the side.

4. Peer-to-Peer Lending

Websites such as Lending Club allow you to earn some passive income by lending to people who need cash and earning interest on those loans. Once you select who you want to lend to, the income will come on its own as long as the borrower can pay you back.

5. Invest in International Stocks

Imagine waking up to find that your investments made money overnight. That's what can happen if you place money in investments from around the globe. Some international investments — especially those in Europe — have performed sluggishly in recent years, but others offer strong growth potential.

If you are intimidated by the idea of investing internationally, don't worry: There are some very solid mutual funds and exchange-traded funds that mirror international markets, meaning you avoid the need to research individual stocks. The iShares Core MSCI Total International ETF is well regarded and has low fees. Funds from the Lazard Fund Family have also performed well.

6. Trade Currencies

The foreign exchange market (or forex for short), is open round the clock, six days a week, and it's possible to schedule trades to take place while you're asleep. Before jumping into the Forex, it helps to know the difference between the Euro and Yen, of course. And trading currencies isn't for everyone — it's volatile, and often requires strong knowledge of global markets. Check out reputable forex courses, such as those offered by TD Ameritrade, first.

7. Just… Sleep

There is some evidence that sleep, by itself, can at least indirectly help you financially. There's no question that getting adequate sleep can make you more alert and productive. But the benefits of sleep may go much deeper. Sleep deprivation has been linked to a variety of ailments ranging from obesity to cancer, so getting enough sleep could be a way to avoid costly medical bills.

Some new research suggests there's a link between inadequate sleep and Alzheimer's disease. Thus, getting enough sleep will help you remain mentally sharp as you age, possibly extending the length of time you can work and earn money.

How do you make productive use of your time sleeping? Perk up and and tell us about it in comments!

This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: