The Scoop on Credit Scores

Credit scores are one of the most important financial numbers.  Credit scores not only affect the interest rate you pay when you borrow, but also your ability to borrow and other important financial transactions. It has been a long time since I’ve borrowed money, so I talked to Cody Jensen, a consumer loan officer at Missoula Federal Credit Union, to get the most current information.  In his role as a loan officer, Cody spends a lot of time educating young borrowers, so he was a terrific resource.  Here is a summary of the interview (with a few tidbits I found on line to expand on a few of his points).

What are Credit Scores?

Most lenders and vendors use the national score calculated by Fair Isaac Company.  It is a number between 300 and 850 that measures your creditworthiness and is sometimes called FICO score.

How are They Used?

Your credit score affects whether you can get a loan (see this post for more about loans) and, if so, the interest rate you will pay.  The lower your credit score, the higher the interest rate you will be charged.

Your credit score also impacts other financial transactions, such as:

  • Landlords use it to evaluate whether to rent to you.
  • The amount that you will pay if you lease a car (see this here for more on leases).
  • Most companies issuing you a contract, such as cell phone providers and cable companies, use it to decide whether you have to pre-pay for your services. That is, if you don’t have a high enough credit score, you will need to pay in advance for your services or make a significant deposit.
  • In many jurisdictions, car and homeowners/renters insurers use it as a rating variable. The lower your credit score, the higher the insurance premium you will have to pay, all other things being equal.

What is a Good Credit Score?

The thresholds vary between categories depending on the user of the information. The chart below shows the approximate distinctions considered by many vendors.

What Determines My Credit Score?

According to Investopedia, there are five factors that determine your credit score:

  • Payment history – Do you pay your bills on time. Timely payment for a long period of time will improve your credit score.
  • Credit utilization – The ratio of the amount you owe to your credit limit on credit cards.While you want a score that is more than 0% (i.e., using your credit cards is good), as the ratio increases above 30% your credit rating will decrease.
  • Length of credit history – The length of time you have used credit, either through student loans, other loans or credit cards. The longer you have used credit, the higher your score will be.
  • New credit – The amount of recent increases to your credit (e.g., new credit cards or loans). Once you have established credit, taking on additional loans or credit cards will lower your score.
  • Credit mix – The types of credit you use. Using different types of credit, such as loans and credit cards, improves your score.

The chart below shows the weights given to each of these factors.

What Can I Do to Improve my Credit Score?

Whether you are just getting started with credit or have an established credit history, here are some things you can do to improve or maintain your credit score:

  • Pay your bills on time. As indicated above, paying at least the minimum payment on your credit cards and making your full installments on any loans by their due date combine to be the biggest contributor to your credit score.
  • Wait until you have a couple of years of experience on your record. By taking the time to establish your credit experience before taking out a loan, you can reduce your interest rate or increase your ability to get a loan.
  • Get a secured credit card. If you are just getting started or need to re-build your credit, you can use this type of credit card.
    • When you open the account, you need to put down a security deposit that is higher than the limit on the credit card, often 110% of the credit limit. For example, if you get a card with a $1,000 credit limit, you’ll need to give the issuer a security deposit of $1,100.  This deposit will be returned when you close the account.
    • Ask someone else to co-sign on the credit card. In this case, the card becomes a shared secured credit card.
    • To improve your credit score, you’ll want to pay off all your charges every month.
    • You will establish a strong payment history, which improves your credit score, by using the secured credit card regularly for a period of time.
    • A secured credit card doesn’t count as a loan so it doesn’t hurt the credit utilization part of your credit score.
  • Make sure there is a balance on your credit card on the last day of the calendar month.
    • That’s when FICO checks your balance, so it is the date on which credit utilization is calculated.
    • You can then pay it off when your bill is due to improve your payment history and avoid interest payments.
    • You score will improve if your balance is between 3% and 30% of your limit on the last day of the month.
  • Check your credit information as maintained by the credit bureaus (Equifax, Experian and TransUnion). This information includes all of your loans and credit cards, your outstanding balance at the end of each month and your payment history.  You are allowed to request your credit report (but not your credit score) for free from each bureau once a year.  If you want it more often than that, you need to pay a fee. You can either enter the information on Annual Credit Report.com’s web site or print a form and submit it by snail mail.  I know a few people who have found mistakes (usually due to identity theft or confusion with a person with a similar name) that have hurt their credit scores. There is a process by which your credit report can be corrected, though it isn’t always easy.

What Are the Causes of Low Credit Scores?

Obviously, not paying your credit card bills or re-paying loans will lower your credit score.  Other factors that can lead to a lower credit score are:

  • Late payments. Again, whether you make your payments on time is the biggest factor in determining your credit score.
  • Too much debt (including credit cards and student loans). If you take on too much debt, you are less likely to be able to re-pay it.  When you have so much debt you can’t keep up with your payments, credit utilization will be too high and payment history could become poor.  These two factors alone drive 65% of your credit score.
  • While a divorce itself does not lower your credit score, some aspects of unwinding the finances can put downward pressure on credit scores.  In many marriages, the couple acquires debt based on their combined income.  For example, many couples rely on both incomes to secure a mortgage for a home.  If the couple gets divorced, they now need two households and neither one has sufficient income to pay off their joint mortgage or other debts.

How Do I Find Out My Credit Score?

Many banks and credit card companies will provide you with your credit score for free.  When I log into my bank’s web site, I can see my FICO score.  You can also pay one of the major credit bureaus (Equifax, Experian and TransUnion) for your credit score.

 

Balancing a Checkbook: The Nitty Gritty Details

In my previous post, I discussed several different options for balancing a checkbook, ranging from completely ignoring it to maintaining a forward-looking transaction record and balancing it every month.  In this post, I’ll give the nitty gritty details of:

  • Balancing a checkbook for a single month.
  • How to get started if you’ve had your account for a while and have never balanced your checkbook.

What You Need

When balancing a checkbook, you’ll need four things:

  • Your bank statement.  Figure 1 provides an example.
  • Your reconciliation from last month.  Figure 2 provides an example.
  • Your check register or transaction record. Figure 3 provides an example.
  • A blank reconciliation template.  Figure 4 shows the template after I’ve completed it as described below for this month.

Getting Started

At the top of your blank reconciliation form (see Figure 4 below) in the row labeled with the letter A , I copy the bank balance as shown on this month’s bank statement.  I’ve put a red A next to that value on Figure 1. In this example, the value is $4,994.16.

Figure 1
Figure 1: Bank Statement

Last Month’s Outstanding Deposits

I then compare the transactions I wrote on last month’s reconciliation with this month’s bank statement.  In our example, I compare Figure 2 with Figure 1. The second section in Figure 2 is a list of all of the deposits that I made before I balanced my checkbook last month that cleared the bank after last month’s bank statement was prepared.  There is one such deposit for $751.64 in Row 2.1.  That same amount can be found as the first transaction on this month’s bank statement (Row 1.1 in Figure 1).  When I find a transaction in both places, I put check marks next to both of them.

Because deposits are recorded by the bank fairly quickly after you make them, all deposits on last month’s reconciliation should appear on this month’s bank statement.  If they do not, you need to make sure you have a confirmation of the deposit and talk to your bank. To make your transaction register balance while you resolve the issue, you’ll need to copy any deposits that haven’t cleared the bank from Section B of last month’s reconciliation to Section B of this month’s reconciliation.

Figure 2
Figure 2: Last Month’s Reconciliation

Last Month’s Outstanding Payments

The next step is to go through the same process with the withdrawals (checks, ATM withdrawals, debit card transactions or any type of automatic or electronic bill pay).  This process will use the third section of last month’s reconciliation (Figure 2) and this month’s bank statement (Figure 1). In Figure 2, I can see that I made payments using Check 1022 and an automatic payment to Allstate (Rows 2.2 and 2.3) before I balanced my checkbook that did not appear on last month’s bank statement.  These items both appear on this month’s bank statement, identified as Rows 1.5 and 1.2 on Figure 1, respectively. As with the deposits, I put a check mark next to each amount on both the bank statement and last month’s reconciliation.

If any of the transactions that were outstanding at the end of last month still do not appear on my bank statement, I copy them to the same place on this month’s reconciliation.  Every once in a while, someone will not deposit a check. I usually assume that any checks that haven’t been deposited after six months won’t be deposited unless there are special circumstances.  When I decide a check isn’t going to be deposited, I don’t transfer the check to this month’s reconciliation. Instead, I put a transaction in my checkbook that shows a deposit for the amount of the check.

This Month’s Outstanding Deposits

I now do the same thing with the transactions I recorded after I balanced my checkbook last month.  In my check register (Figure 3), I see three deposits (Rows 3.5, 3.6 and 3.10). On my bank statement (Figure 1), only the first two deposits appear.  They are shown in Rows 1.6 and 1.8 of Figure 1 and correspond to Rows 3.5 and 3.6 of my check register. I put a check mark next to Rows 1.6 and 1.8 on the bank statement and Rows 3.5 and 3.6 in my check register to indicate that I have found the amounts in both places. At the same time that I enter the check marks, I also compare that the amounts are the same.  

Amounts Don’t Match

If the amounts don’t match, it could be one of two problems:

  • The bank used the wrong amount for that transaction.  I then need to find any documentation I have (check stubs, copies of deposits, confirmations of electronic deposits) so I can demonstrate to the bank that there is an error.  If that is the case, I treat any difference as an outstanding deposit as explained below.
  • I entered the wrong amount in my check register (the more likely problem).  In this case, I add another entry at the bottom of my check register that adds or subtracts the difference.  I illustrate corrections of arithmetic mistakes below. Correcting entry errors uses the same process.

Deposits Not on Bank Statement

You’ll recall that the deposit in Row 3.10 of my check register did not appear on my bank statement.  I take some piece of identifying information about the deposit (I always use the date) along with the amount and enter it in Section B of this month’s reconciliation (Figure 4).  You’ll see I entered $751.64 in Row 4.1 of Figure 4.

I then calculate the total of the values in this section of Figure 4.  I enter that amount in the Total row of the little table and on the blank line just to the right.  As indicated on the reconciliation form, I then add the ending balance from my bank statement to the total amount of outstanding deposits in C.  That total is $5,745.80.

Deposits Not in Check Register

If there are any deposits on my bank statement that do not appear on my check register, I add them.  I find those deposits by looking on my bank statement for any values in the “Paid In” column that don’t have a check mark next to them.  My bank pays a very small amount of interest on my checking account every month. I never remember to record the interest as a deposit on the day it goes into my account, so have to add a line my check register for that deposit.

So far, I have adjusted the amount the bank recorded as my balance on the date the statement was prepared for deposits I made subsequently.  Remember the goal of this process is to make sure the bank statement balance equals my checkbook balance after adjustment for any transactions that don’t appear in both places.

Figure 3
Figure 3: Check Register

This Month’s Outstanding Payments

I next focus on the payments I made this month.  There are seven of them shown in the Withdrawal column of my check register (Figure 3).  The transactions to Safeway, Petsmart and Amazon were made by debit card. The payments for my mortgage and insurance (Allstate) are automatic payments.  I recorded that I wrote one check, as shown in Row 3.9, and transferred $800 to savings (Row 3.8).

I look for each of these transaction on my bank statement in Figure 1.  As with the deposits, I put a check mark on both the bank statement and check register next to all of the amounts that appear in both places.  I also check to make sure that the amounts are the same. If they are not, I need to figure out who made the mistake and take the same types of corrective actions as I did for deposits.

Expenses Not on Bank Statement

You’ll see that all of the transactions except the check to Jane Doe (Row 3.9) and the auto-pay transaction to Allstate (Row 3.11) appear on my bank statement.  I copy the information and amounts of these two transactions (Rows 3.9 and 3.11) into the table in Section D of my reconciliation. You can see those amounts in Rows 4.2 and 4.3 of Figure 4.  I calculate the total amount of outstanding payments and put it in the bottom row of the table in Section D and the line next to it. This value is $656.89.

Figure 4
Figure 4: This Month’s Reconciliation

Expenses Not in Check Register

I look to see if there are any payments on my bank statement that weren’t in my check register.  These payments won’t have a check mark next to them. As is often the case, I didn’t record the cash I withdrew on 9/22 of $300.  Figure 5 has a corrected copy of my check register. You can see in Row 5.1 where I’ve added the cash withdrawal I forgot to record.

Figure 5
Figure 5: Corrected Check Register

Making It Balance

The last step for completing the reconciliation is to subtract the total amount of outstanding payments shown in the Section D Total from the amount in C in Figure 4.   The difference ($5,745.80 – $656.89 = $5,088.91) goes in the line next to E of Figure 4.

If I’ve done everything right, the total from E equals the balance in the last line of my check register.  

Finding Errors

Unfortunately, that usually doesn’t work for me and didn’t in this example. The adjusted bank balance from the reconciliation is $5,088.91 as compared my checkbook balance (after adding the missing ATM withdrawal) of $5,092.91.  There are several different things that can cause the values to differ. Here are the things I check:

  • Make sure all transactions on my bank statement have a check mark next to them.  If not, I need to add them my check register. For me, this error is a common one, as it is easy to forget to record an ATM withdrawal or a check my husband wrote.
  • Confirm that all of the amounts on the bank statement are exactly equal to the amounts on either last month’s reconciliation or my check register.  
  • Confirm that all of the outstanding amounts (the ones that are not checked) in my check register and from last month’s reconciliation are recorded correctly on this month’s reconciliation.
  • Check that my arithmetic is correct on this month’s reconciliation.  I start by doing the arithmetic in my head, so often find mistakes here.  This problem is common if I have a long list of outstanding payments because I didn’t balance my bank statement right after it arrived.  If I’m really stuck, I’ll open a spreadsheet to do the math for me.
  • Check that the arithmetic is correct in my check register.  Because I often update the balance in my check register while I am at the check-out counter of a store, I’m somewhat distracted so this error is my most common one.

Correcting Errors

In this case, I found that I made two arithmetic errors when calculating the balance in my check register.  When I deducted my mortgage payment from my balance in Row 3.4, I incorrectly calculated the value that goes in the $1 column.  The correct balance for that row should have been $4,826.86. Rather than write over the errant 5 and carry that correction all the way down the rest of the column, I create a new line item.  This line item is shown in Row 5.2 of Figure 5. I also made a $5 subtraction error related to my Amazon charge. In this case, I subtracted $5 too little, so I added Row 5.3 on Figure 5 subtracting that $5.

With these changes, the balance at the bottom of my corrected check register (Figure 5) equals the adjusted bank statement balance (Figure 4) and I am done for this month.

How Do I Get Started

It is never too late to start!  It will just be a bit challenging at first because you don’t have a “Last Month’s Reconciliation.”  Here’s how I suggest you get started if you’ve never kept a check register or balanced your checkbook.

Start a Check Register or Transaction Record

Initially, you won’t have to keep track of the balance – just record all of your transactions.  You can keep your transaction record in any format that works for you. I still carry a check book, so I use a check register from the bank as my transaction record.  You’ll want to create a process that allows you to (a) make a note of all transactions as soon as you make them and (b) allows you to track your balance.   I see there are some apps for this purpose, so one of them might work well for those of you who always have your phone with you.

Compare Bank Statement with Check Register

After you have at least one month’s transactions, compare the transactions on your bank statement with those on your transaction record.  Mark all of the ones in your transaction record that are also on your bank statement. If there are a lot of transaction on your bank statement that didn’t appear in your transaction record, wait for another month.  You’ll want to track the number of transactions on your bank statement that come from transactions you made before you started your transaction record. Once that number is pretty small, you are ready for the next step.

Calculate Adjusted Balance

Go through the process of calculating your adjusted balance described above.  In the first month, you will have to look back in prior months in your transaction record for transactions that cleared this month but you recorded previously because you won’t have the list of outstanding transactions from last month.

Check Adjusted Balance

Check your adjusted bank balance carefully, as you are going to use this as the balance in your transaction record.  Put the adjusted balance amount in the balance column of your transaction record next to the most recent transaction you have entered.

Unless you have made an arithmetic error in calculating your adjusted bank balance or you have a transaction outstanding from before your started your transaction record, you will be able to balance your checkbook in future months.

Closing

The above explanations have lots of steps!  If you have any questions or need help when you try to apply them to your own situation, feel free to either post questions below or drop me a note via the Contact Me form or at susieq@financialiqbysusieq.com.  As always, though, please, please, please do not include any personally identifiable or personally sensitive financial information.

 

Balancing a Checkbook: Benefits and Risks

I was pleasantly surprised to see that some of my readers are interested in balancing their checkbooks to their bank statements!  I would have guessed that, although I balance my checkbook to the penny every month, there wouldn’t be much interest. In response to this request, I will talk about the following aspects of balancing your checkbook in this post I describe the nitty gritty details of balancing your checkbook in a separate post.

  • How to balance your checkbook for a single month.
  • How to get started if you’ve had your account for a while and have never balanced your checkbook.

Benefits

The primary reason to balance your checkbook is to make sure that you always have an accurate picture of your financial position.  A list of your bank account transactions is often called a checkbook, check register or transaction record. By maintaining such a list, you can keep track of your current account balance to monitor whether you are staying on track with your budget or whether you can afford a particular purchase.  When you balance your checkbook, you are confirming that you have included all transactions and performed all of the calculations correctly.

A secondary reason to balance your checkbook is to ensure that none of the bank, you or any vendors has made a mistake.  Although it has been many years since it has happened, I am aware of a few mistakes with my account. In one case, the bank transferred money from my checking account to my savings account instead of the other way around.  In another case, the bank put the money from a large deposit into someone else’s account. I also had a utility that I paid by automatic transfer take too much out of my account one month. My mother had a deposit she had mailed to a brokerage firm get burned up in a plane crash on its way to the bank.  So, you never know!

Basic Steps

When I think of balancing my checkbook, I envision the key steps as:

  • Compare the deposits and withdrawals on my statement with the ones that were outstanding when I balanced to my statement last month.
  • Compare the deposits and withdrawals on my statement with the ones I entered in my transaction register since I balanced to my statement last month.
  • Adjust the balance on my bank statement for any transactions that are in my checkbook that aren’t on my bank statement.
  • Make sure that the adjusted bank statement balance equals the value in my checkbook, finding any missing transactions or arithmetic mistakes if they aren’t the same.

Six Variations

In practice, I’m aware of at least six different ways you can use your bank statement, in order from riskiest and least effort to lowest risk and most effort.  These approaches are:

  • Ignore the whole thing and assume that whatever the banks says is your current balance is right and up-to-date.
  • Review your bank statement every so often to make sure all of the transactions look accurate.  Trust that the bank balance you see on your phone or online is right and up-to-date.
  • Keep a checkbook without keeping track of your balance.  Use it to compare with your bank statement to make sure all of the transactions on your statement are right.  Or, some bank apps can send you an e-mail or text for every transaction on your account as it happens so you can check them.  In either case, you trust that the balance reported by the bank is right and up-to-date.
  • Keep a checkbook and keep track of your balance.  Use it to compare your transactions to your bank statement.  Do a partial reconciliation with your bank statement, but adjust your checkbook balance to the adjusted bank statement balance (see below) once you get close.
  • Keep a checkbook, keep track of your balance, and balance your checkbook to the penny every month.
  • Keep a checkbook but include not only transactions you have already made, but also record any amounts you know you need to pay at the same time you record your paycheck or other deposit.  Also, calculate your balance and reconcile your checkbook every month.

What Do You Mean – Up-to-Date?

Many people look at the balance reported by the bank at a particular moment and assume that it represents their available funds.  That assumption is closer to being true today than it was 20 years ago, but it is not always a good assumption to make. Your checkbook, if you are diligent about recording transactions immediately, will reflect all of these charges so you will have an up-to-date balance. The factors that cause there to be differences between the balance reported by the bank and your available funds include:

Holds

Banks sometimes put a hold on part or all of certain deposits, especially ones that are large relative to your balance or come from other banks.  That is, the bank will not let you spend the amount that has been put on hold until it “clears.” I have had deposits take up to ten business days to clear, though three business days seems to be more typical.  The total amount of your deposit will show in your balance, but it may not be available. In many cases, I’ve seen the bank report two balances – the total and the available balance. The available balance excludes the portion of any deposits that have been held.  If you see only one balance, make sure you know whether it is the total or the available balance so you don’t overdraw your account.

Check Processing Time

Checks always take at least a bit of time to be reflected in your balance.  If you pay a bill and mail a check, it won’t clear the bank until the payee has received and deposited it.  I find this lag can be as long as ten days. Even if you give a check to a vendor or service provider in person, it can take a few days for it to be deposited.   Until the check has been deposited by the payee and your bank has been notified, the amount of the check will be included as part of the balance reported by your bank.

Scheduled Bill Pay

If you schedule a bill payment directly from your account, some banks and platforms do not be deduct the amount from your balance until the vendor accepts the payment.  For example, if it is the 5th of the month, you schedule a payment for Saturday the 8th and the vendor doesn’t accept the payment until Monday the 10th, your balance will not reflect that payment for the five days after you committed to making the payment.  One exception is an Interact e-transfer which is deducted from your account balance immediately.

Debit Charges

Most debit charges clear almost instantly, but there are situations in which they don’t.  One example is tips. Many vendors process the amount of your bill immediately, but then give you the receipt on which you add the tip and then sign.  In some cases, it can take a day or two before the vendor processes the tips. This situation isn’t as common in places like Canada where the tip is entered directly into the card reader at the same time the transaction is approved.

ATM Fees

Almost all ATM withdrawals are processed instantly, as well, though there is sometimes a small lag if you withdraw money outside your own country or with the fees charged for using another bank’s ATM.

Which Approach is Better for You

The table compares how each of these approaches addresses the two primary risks of not balancing your checkbook – identification of mistakes and an up-to-date view of your balance.

Approach/Level of Effort Error Identification Account Balance Accuracy
Ignore the whole thing None Rely on bank for your current balance.  Ignores any transactions that you have made but haven’t cleared or that need to come out of your current funds
Review statement Will find bigger mistakes and those from locations where you weren’t or vendors you’ve never used Same as above
Keep a checkbook and compare with statement Will find most mistakes, as long as your checkbook is complete Same as above
Keep a checkbook, calculate your balance and compare with statement Same as above As long as you haven’t made any math errors in calculating your adjusted balance, you have an accurate view of your current financial position including transactions that haven’t cleared
Balance your checkbook Same as above with additional confirmation that you have caught all errors from the balancing process You have an accurate view of your current financial position including transactions that haven’t cleared
Include  expenses that need to be covered by this paycheck Same as above You know how much money you have available for discretionary purchases until your next paycheck or other income arrives

If you are on a very tight budget or if you know yourself well enough to know that you are an impulse shopper, the “include expenses that need to be covered by this paycheck” approach is likely best for you from a risk perspective.  If you have a bit of cushion or know you can stay on your budget without going the extra step of anticipating expenses, you are likely safe using the “balance your checkbook” approach. I have always used that approach and still do.

Key Risks

There are two key risks of not knowing your up-to-date bank balance – not having money to pay a critical bill and overdrawing your account. Most importantly, you don’t want to find that you can’t afford to pay your rent, mortgage, utilities or insurance because you didn’t keep track of your bank balance. Almost as importantly, you don’t want to “bounce” any of your transactions. If you have a check, delayed debit card or ATM transaction or electronic payment that demands more funds from your account than your current balance, you can incur a lot of fees. Normally, your bank will charge you a fee for every transaction that arrives when your balance is less than zero. In addition, the store, restaurant of vendor is likely to charge you a pretty hefty fee. I recall one time when my bank made a mistake and thought I had overdrawn my account. Several small checks cleared the bank before I discovered the error. I had a $20 charge from the bank for every one of those charges, plus fees from some of the vendors. The charges were more than the total amount of those checks! (The bank refunded the fees and covered the vendors’ charges, so I ended up not paying anything fortunately.) Many banks offer overdraft protection. If you have that protection, it can save you fees if you do overdraw your account, but you’ll want to consider that a temporary solution and re-pay the bank as quickly as you can.

The more money you have in your checking account, the more you are able to take on the risks of the other approaches.  I know lots of people who have used them for years and haven’t gotten into financial trouble. Unfortunately, I also know some people who have encountered significant financial issues due to a lack of budgeting, keeping track of money or unexpected large expenses.  And, to be clear, even the rich can struggle with budgeting and tracking money, as illustrated by some large lottery winners who splurge their winnings and actors whose earnings have been mismanaged. These situations are awful for them and for the people who care for them.

I get it, though!  Remembering to write your transactions in a record, doing the mental math to keep the balance and balancing your checkbook every month are somewhere between a nuisance and a pain.  So, pick the approach that is going to work best for your willingness to put in the effort and your tolerance for risk.

Acknowledgements

Thanks to my contacts at Security Bank in Helena for helping me understand when different types of transactions will be reflected in your bank balance.