By Herb Weisbaum
msnbc.com contributor
updated 1:33 p.m. ET, Wed., April 29, 2009

Last week’s column on credit scores generated a lot of comments and questions. Olga, who says she has excellent credit, sent me an e-mail that sums up the frustration of so many. “I feel that no matter what a consumer does, no matter how careful you are with your credit, whatever you do, they tell you it could lower your credit score. A consumer cannot win!”

I understand the frustration. Your credit score now controls so many aspects of your life: whether you can rent an apartment or get a car loan, credit card or mortgage. I think everyone knows late payments will hurt their score. But other than that, most don’t have a clue as to how credit scores are computed.

Here are the answers to some of your questions.
Q: A department store chain is going out of business and I have one of their store-branded Visa cards. The bank that issued the card says once the store closes its doors for good they will close my account. Would it be better for my credit score if I close the card myself before the bank does?

A: It doesn’t matter who closes the account. That isn’t one of the factors considered when computing your credit score. But closing an account – whether it’s done by you or the lender – can have a short-term negative impact on your credit score. This is due to what’s called debt utilization – the ratio of your total debt to total credit limit – and it counts for about a third of your credit score.

“Closing a credit card reduces your available credit, but doesn’t reduce the amount you owe, making it look as if you’re using more of your available credit,” explains Greg McBride, senior financial analyst with bankrate.com.

Here’s how that works. Let’s say you have four credit cards and each has a $5,000 limit, making your available credit $20,000. You have no balance on one card and a combined balance of $6,000 on the other three. Your utilization rate is about 30 percent. That’s not bad. Credit experts say you should try to use 30 percent or less of your available credit.

What happens if you decide to close the card with the zero balance because you don’t use it anymore? Your available credit drops by $5,000 but your total debt doesn’t change. So your utilization rate jumps to 40 percent ($6,000 debt on $15,000 of available credit) and your credit score will drop.

Craig Watts, public relations manager at Fair Isaac, the company that created the FICO score, says if you close a card and you have virtually no balance on your other cards “the impact on your score will be negligible.” Watts says it won’t hurt you if you go from a 2 percent to a 10 percent utilization rate. But jump from 10 percent to 50 percent and “you’ll get clobbered.” So you need to do the math before you close an account.


If you have a good reason to close a card, such as a big annual fee on a card you don’t use, then consider closing it. Just don’t close a bunch of cards at once. And don’t close credit accounts if you plan to apply for a car loan or mortgage in the next six to twelve months.

Q: Why do we have to pay a fee in order to see our credit scores? Annual credit reports are available at no charge. These scores are so important, why aren’t they free as well?

A: Congress never included credit scores when it required the big three credit bureaus to give you one free credit report each year. Many consumer groups believe this should be changed. But the industry makes a lot of money selling these scores.

Want to know your score? You’d be smart to get it from FICO because it’s the most widely used score. If you’re applying for a mortgage, you’ll also want to get a score from Experian. They no longer make their FICO score available to the public.

Bankrate.com has a FICO Score Estimator, a free calculator that will give you an estimated range for your FICO score based on 10 questions. It’s a simple way to figure out where you stand when you have no plans to apply for credit.

WASHINGTON (Dow Jones)–The Obama administration unveiled a fresh set of incentives Tuesday for mortgage servicers to help strapped U.S. homeowners.

Under a new program, the government will pay mortgage servicers $500 up front and $250 a year for three years for successfully modifying a second mortgage, such as a home equity loan.

Second mortgages have complicated government efforts to help borrowers avoid foreclosure. According to the U.S. Treasury Department, up to 50% of at-risk mortgages have second liens and many properties in foreclosure have more than one lien.

Senior administration officials Tuesday told reporters they expect a significant amount of big banks to sign up for the updated federal program to bring relief to troubled homeowners. Once those firms sign necessary contracts, they’ll generally be obligated to modify second liens when they’ve initiated a modification on the first, the officials said. They also noted that the second lien program will be funded by the $50 billion in Troubled Asset Relief Program, or TARP, funds the administration had already projected to use for home affordability efforts.

Additionally, the administration unveiled a schedule of incentives for holders of second mortgages to extinguish those liens voluntarily.

The administration also announced a set of incentives for servicers and lenders participating in the Hope for Homeowners program, which aims to restore homeowners’ lost equity by encouraging lenders to write down loan principal. The administration said it will take steps to incorporate Hope for Homeowners into its loan modification program. Servicers will be required to determine eligibility for a Hope for Homeowners refinancing and where it proves viable, the servicer would need to offer this option to the borrower.

While participation in the Hope for Homeowners program has been dismal, administration officials said they’re expecting strong investor interest as the program is wrapped into the broader federal loan modification program. The administration also said it supports legislation to strengthen the Hope for Homeowners program so that it can function effectively as a key part of the administration’s new housing efforts.

“With these latest program details, we’re offering even more opportunities for borrowers to make their homes more affordable under the administration’s housing plan,” Treasury Secretary Timothy Geithner said in a statement Tuesday. “Ensuring that responsible homeowners can afford to stay in their homes is critical to stabilizing the housing market, which is in turn critical to stabilizing our financial system overall.”

During a conference call, senior administration officials said they are continuing to work on key elements of the president’s plan to stem foreclosures and agencies will be developing more details and guidelines going forward.

Tuesday’s announcements are expected updates. The issue of second mortgages has been dogging policymakers ever since the onset of the foreclosure crisis. A large share of troubled borrowers also have a second mortgage on their home, which is typically owned by a different investor than the first mortgage. Such borrowers may not be able to afford their monthly payments if only the first mortgage is modified.

The administration’s effort on second mortgages is also aimed at soothing the concerns of investors, who have been crying foul over the Obama housing plan’s incentives for servicers. They argue the first mortgage shouldn’t be modified if the second one is left untouched. They also contend the banks that dominate mortgage servicing are conflicted because they own more than $400 billion of second mortgages. Such banks stand to gain from modifying the first mortgage because the second mortgage is more likely to be repaid once the homeowner is saved from foreclosure.

Some of the largest U.S. banks, including Bank of America (BAC), Wells Fargo (WFC) and JPMorgan Chase (JPM), have already agreed to sign on to the program, the official said. The rest of the industry will be encouraged to participate.

Under the program, servicers must agree to modify all second mortgages where the first mortgage has already been modified. To qualify for payment, servicers must extend the term of the second mortgage and reduce the interest rate to match the first mortgage. Then, the government will share the cost with the servicer of reducing the rate down to 1% for amortizing loans and 2% for interest-only loans.

Borrowers will receive payments of up to $250 per year for as many as five years if they stay current on the loan. The payments will be applied to pay down principal on the first mortgage.


Changes to the Hope for Homeowners program are designed to place it in line with the taxpayer-assisted loan modifications. Launched last fall to help troubled borrowers refinance into more affordable government-backed loans, it has failed to gain traction due to onerous borrower requirements and the nagging problem of second liens.

The administration announced Tuesday a $2,500 up-front payment to servicers that refinance borrowers into the program. Meanwhile, lenders that originate the new loans will receive $1,000 a year for three years, if the loans stays current.

It will go down as one of the biggest — and most popular — bailouts of the credit crunch. But who will pay for it later?

The Federal Reserve is buying hundreds of billions of dollars of low-interest-rate mortgages guaranteed by Fannie Mae and Freddie Mac. The purchases, which so far amount to $250 billion and could grow to $1.25 trillion, have driven mortgage rates to historical lows, inducing house purchases and sparking a refinancing wave.

This serves key social and political goals: It helps shore up house prices, while the lower mortgage rates put extra money into the pockets of people who aren’t struggling to service their mortgages. This then makes them less likely to oppose taxpayer-funded moves to support homeowners facing foreclosure.


What’s more, banks holding Fannie and Freddie securities get to book big gains as the Fed’s buying spree drives up prices. Analyst Meredith Whitney estimates the top 10 banks by assets increased their holdings of securities issued by Fannie and Freddie and government agencies by $128.6 billion, or 30%, in the fourth quarter. Those will be marked higher in the first quarter.

Most convenient of all: This mortgage buying is being done by the Fed, which doesn’t need approval from Congress for the purchases.

On paper, it is a dream bailout. It benefits not just large banks but also ordinary people, it is hard for politicians to tamper with, and the Fed doesn’t have to borrow money to fund the purchases — it just prints it instead.

When something looks this good, it pays for investors to dig deeper. And the risks abound.

The biggest is that the purchases will deal another blow to the credibility of the Fed, whose monetary policies helped stoke the credit boom.

Of course, printing money carries inflation risk. And the Fed’s aggressive actions, led by Fed Chairman Ben Bernanke, mess with market pricing. The mortgage purchases could help increase assets on the Fed’s balance sheet to $3 trillion, equivalent to more than 20% of gross domestic product. So when it stops buying, mortgage rates could rise sharply.

The size of the Fed purchases are already overwhelming private markets. Right now, there is limited investor demand for Fannie and Freddie mortgages with coupons under 5%, due to the risks of holding such low-yielding paper. Filling that gap, the Fed purchased $192 billion of 4% and 4.5% conforming mortgages, on a gross basis, in the four weeks ended March 25.

Holding this risky paper could damage the Fed later on. If it wants to sell 4% mortgages to private investors, it would likely have to do so at a price that creates a yield above 5%, potentially triggering a loss for the Fed. It could, of course, choose to hold the mortgages to maturity, with any credit losses covered by Fannie and Freddie.

The mortgage buying also could alter the Fed’s core mission in a detrimental way. In an unusual joint statement last month, the Fed and Treasury said the Fed’s job wasn’t to “allocate credit to narrowly defined sectors or classes of borrowers.” Yet focusing so much money on residential mortgages, and thus homeowners, seems to do just that. Investors might come to expect support-purchases every time an asset gets into trouble.

Finally, the Fed’s actions may attract congressional scrutiny. “Everything’s fine as long as the Fed is making perfect decisions,” says Rep. Scott Garrett (R., N.J.). “The challenge for Congress is: Can we do anything to create oversight to address that.”

This bailout mightn’t stay backdoor for long.

Write to Peter Eavis at peter.eavis@wsj.com