Why Credit Should Be Used Regularly

Question: My mother pays for most large purchases with cash. She wrote checks to buy three cars in the last year — two luxury cars and a sport utility vehicle — yet according to lenders, she has bad credit.

Why do people like her, who use credit cards only for emergencies and then pay them off at the end of the month, get penalized when they want to buy something big like a house?

Answer: Your mother may not have bad credit. What she may have is a credit history that’s too thin to generate the three-digit credit score that most lenders use to judge a person’s creditworthiness.

The FICO scoring formula requires a consumer to have at least one account on her credit report that’s been open a minimum of six months and at least one account to be updated in the previous six months.

This requirement can make it tough for young people and immigrants to establish credit, because many lenders won’t open an account if the applicant’s credit history is too thin to generate a credit score.

But, as you’ve seen, the requirement also can hamper the well-off who choose not to use credit regularly. Paying for everything with cash might be smart for them financially, but they may find themselves unable to get loans at decent rates when they need to borrow.

The fix for this problem is fairly simple: Your mom would just need to use her credit cards more regularly. She doesn’t have to carry a balance; the FICO credit scoring formula doesn’t distinguish between balances that are paid off and those that are carried month to month.

All she would have to do is make a few small charges each month and pay them off promptly. She should avoid “maxing out” her cards or even using more than about 30% of her credit limit, and she should pay the bill on time. She could even put this on automatic, by having some regular expense such as a newspaper subscription charged to her card and then authorizing the payment directly from her checking account.

How Much House Can I Afford to Buy?

Q: I’m 21 and thinking about buying my first home. How much house can I afford to buy, and is it OK to bid less than what the seller is asking?

A: You have actually asked two of the more difficult questions to answer when it comes to real estate.

Many people believe there are strict formulas that determine how much they can borrow for a home. In reality, lenders have loosened their standards considerably in recent years, and some borrowers may find — much to their later sorrow — that they can get a much bigger mortgage than they can comfortably repay.

A good rule of thumb is to keep your total housing costs — including mortgage, taxes and insurance — to about 25% of your gross income. That way, you’ll have enough money for other goals, such as retirement savings and vacations.

You can stretch a bit more if you expect your income to rise considerably within a few years or if you have no other debt. But you might want to be even more conservative if your income is uncertain or your debt load is particularly heavy.

Once you have a target monthly payment, you can play with the online mortgage affordability calculators offered by companies including Bankrate Inc. and E-Loan Inc. to see how much house that will buy.

As far as how much to bid, you might consider consulting an experienced real estate or buyer’s agent who is well-versed in the neighborhoods you’re targeting for your house hunt.

There are no hard-and-fast rules. Some sellers overprice their homes; others set the price too low, hoping to set off bidding wars. A smart agent can help you figure out which is which and coach you on the best bidding strategies for your market.

101 for Identity Theft Victims

Q: My stepson is a victim of identity theft. Are there any government agencies or other organizations that he might contact for help?

A: The only good thing about the identity theft epidemic — the Federal Trade Commission estimates 9.9 million victims in 2003 alone — is that plenty of resources have sprung up to help the victims.

Your stepson still has a lot of work ahead of him. He can turn to others for education and information, but he’s the one who will need to contact the credit bureaus, file a police report and take the other steps necessary to clear his name.

He can’t expect anyone else to do the work for him, and he’ll be lucky if any official investigation is conducted. Most police departments place a pretty low priority on identity crimes, and research firm Gartner has estimated that the thieves face only a 1-in-700 chance of being caught.

But your stepson can limit the damage. He can get information from the FTC by visiting its consumer website at www.consumer.gov/idtheft/ or by calling (877) FTC-HELP (382-4357). Make sure he gets a copy of the FTC’s “ID Theft: When Bad Things Happen to Your Good Name.”

He also can check out the Identity Theft Resource Center, a nonprofit organization that recently won a National Crime Victim Service Award from the Department of Justice. Your stepson can visit its website at http://www.idtheftcenter.org or call the center at (858) 693-7935.