One way for planners to help clients access credit at lower interest rates is to teach them how to manage their FICO scores. This score can range from 330 to 850. The higher the score, the better. To get the best interest rates, clients should try to keep their FICO scores at 760 or higher. The score value is based on information from credit reports. Understanding how this information affects the score can provide an opportunity for planners to help clients make the right decisions to increase their FICO scores.
Payment History, Amount Owed and Length of Credit History
Payment history is the largest factor in the score. Planners should make sure clients understand the importance of making payments on time. When students enter college, they will typically apply for their first credit card. Students should do so with the understanding that failing to make timely payments can impact their ability to qualify for other types of credit like auto and home loans. This impact can continue well into the future.
The second major factor affecting the FICO score is the amount that’s owed. It’s an assessment of whether or not a borrower might already be overextended on credit. Being overextended means the borrower may have borrowed so much that he or she is unable to make the payments required on this amount of debt. Utilization affects the score positively if credit cards are used periodically and paid on time, but there is no effect on the score if someone has a credit card available but never uses it.
The longer the credit history, the better the score. In the example of the college student getting his first credit card and making timely payments, he’s also increasing his credit score for buying a home in the future by having a longer credit history from the credit card account.
Types of Credit and New Credit
Ten percent of the FICO score comes from looking at the types of credit that are used. These types include credit cards, retail cards, installment loans, finance company accounts and mortgage loans. Having a credit card and using it responsibly provides a higher score than not having any credit cards at all.
The final category that affects the FICO score is new credit. Opening several accounts in a short period of time can indicate a higher credit risk and will lower the score.
Checking a Credit Score
When a consumer checks his or her own credit score, there is no impact on the score, and it is recommended that clients check credit reports on a regular basis to identify and correct any errors and to ensure that there has not been an identity theft situation. Every individual is entitled to one free copy of the credit report from each of the three credit bureaus each year. A good practice to monitor activity throughout the year by requesting a report from a different company every four months.
Most people recognize the need for homeowners and automobile insurance , even if they don’t appreciate how much property and casualty coverage they should have.
A mortgage lender will typically require insurance on the mortgaged property, but in any case it would be foolish not to have it. The loss of a home could be financially devastating, and even partial losses can put a significant dent in a family’s financial security. It is important to have sufficient coverage to replace the dwelling, and although contents are generally included, special endorsements may be necessary to cover certain valuables such as jewelry, art or furs. In some areas it is important to procure specific coverage for perils generally excluded, for instance earth movement or floods. Another significant piece of the HO policy is liability coverage, in case the homeowner is found responsible for injury or damage to other persons or property.
People who rent their home might overlook the necessity for insurance, but it’s just as important for them to obtain coverage for their personal property, as well as liability protection. The landlord’s policy does not cover the tenants. Renters insurance is similar to homeowners except that the dwelling itself and related structures are not included. However, any improvements added by the tenant can be covered by an endorsement. There is also a special policy type for condominium owners. A good way to be prepared in case there is a need to file a claim is to go through the house and videotape the contents of each room, storing the video at some secure offsite location, or perhaps online.
Auto liability insurance is another critical item, and most states require at least a minimum amount of coverage on registered vehicles. (Some states may allow proof of financial responsibility as an alternative to insurance.)The required minimum is usually inadequate in the case of any major mishap so if the client has significant assets to protect, this should be considered in choosing the amount of coverage. Auto liability coverage can be a split limit or single limit. With a split limit, e.g. $100,000/$300,000/$50,000, the first number is the maximum amount that will be paid for bodily injury to any one person, and the second is the maximum for bodily injury per accident, and the third number is the maximum that will be paid for property damage. A single limit will pay the stated amount per accident, without any restriction on how much goes to one person. The limit of liability for property damage is a separate amount.
Further protection can be obtained to cover theft or damage to the insured vehicle. It comes in two parts, collision and ‘other-than-collision,’ formerly known as comprehensive. There is usually a deductible amount for claims under these coverages, and the insured should consider how much he or she is able to pay out of pocket when choosing the deductible. A higher deductible may be worth the premium savings. For some older vehicles this damage protection may not be worth buying, depending on a number of factors, including the cost of coverage and the amount the insurer will pay vs. the value of the vehicle.
In analyzing a client’s insurance coverage, keep in mind the aim of protecting assets. Often a person of higher net worth will need additional liability coverage in the form of an umbrella policy, which protects above the limit of the HO and auto policies. One rule of thumb is to have coverage equal to the client’s net worth.
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People have many reasons for not being involved with a financial planner. Some are deterred because they consider financial planners to be merely glorified insurance sales people. While this is clearly a misconception, one aspect of thorough financial planning is to make sure a client’s assets are protected, and insurance is a valuable tool for this purpose. The planner would be remiss if he or she did not discuss it with clients when appropriate.
One type of insurance that might immediately come to mind is life insurance. Not everyone needs life insurance, but anyone who has a family to support or other people depending on his or her income should have this coverage. It can also be useful to provide a bequest for heirs or leave a gift to charity. Perhaps there is a large mortgage on the home or a vacation property, and the client wants to ensure that it gets paid off so heirs will not be forced to sell if they don’t want to.
Life insurance is a complex subject; there are many different options, and always new twists being introduced. A planner can help clients to figure out whether they need life insurance, as well as how much and what type would be most appropriate.
Another insurance consideration that’s often overlooked is disability income insurance. People will obtain insurance coverage for their property and possessions, but overlook the value of their ‘human capital,’ the ability to go to work and earn a living. For those in the early stages of their career, human capital may be their most valuable asset. Most people take the ability to work for granted, and don’t give much thought to the possibility of accident or illness depriving them of this capacity. But how would they pay their mortgage or put food on the table if they were unable to work?
Those in good health and practicing healthy habits might think a disability won’t happen to them, but catastrophe can strike anyone. It might surprise some people to learn that they are much more likely to need disability insurance than life insurance during their working years.
According to recent statistics, about 25% of those just entering the workforce will have a disability lasting 90 days or more sometime during their career. Social Security might help somewhat, but there is a 5 month period before a person is eligible, and the rules to qualify are very strict, so it shouldn’t be too heavily relied on. But disability income insurance can save the day. Some people have coverage through their employer, but it may not be sufficient, for instance if a large part of compensation is via bonus rather than base salary. In such cases a separate individual policy might be advisable.
Some things to consider when choosing a disability policy are the elimination period (length of time of disability until the benefits begin), the percentage of income it will replace, and the definition of disability. Social Security will pay only if you are unable to perform any job, while most private policies are less restrictive, based on inability to perform your own occupation or possibly a related one. There are other variables and complexities as well, and like life insurance, this is where a savvy financial planner can put a client on the right track!
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