Most Americans don’t know anything about credit reports and credit scores, even though they can get a free credit report every year – and don’t care. So long as they can get a car loan or a credit card then everything is OK and there is no reason to inquire any further.
That idyllic attitude may soon clash harshly with reality as the nation’s lenders tighten their belts and become more selective about whom they will loan money to – for any reason. Everybody has heard of the “sub-prime mortgage crisis” even if they do understand what it means.
Here is the 25 cent explanation about how the sub-prime lending crisis hurt the credit markets and will cause changes, and for the worst for most people, in how much money lenders will be able to make available to consumers in the coming several months or years, and how difficult it may become to get a loan for a house or a car or for almost anything.
An individual bank, credit union, finance company and other lender can only loan a certain total amount of money. That amount, which is for all the loans made by that lender to every borrower, is based on its capital. As more and more sub-prime loans stop being paid and default these lenders are required by law to write-off the value of the unpaid loans. Every unpaid loan is a hit or reduction on capital. The more unpaid loans that a lender accumulates the greater the hit on capital, all of which results in less money that lender can make available to other borrowers in the future.
When you consider that banks and other financial institutions loan heavily to each other, you can see how an unusual number of defaults in one sector, like sub-prime mortgages, can have a snowball effect across the entire lending industry. All this does not mean that the financial services industry is going to crash, but it will change.
What it does mean in practical terms is that loan officers will not risk their jobs by approving loans to “risky” borrowers. OK. So who is a risky borrower? Are you a risky borrower?
For consumer finance, which includes mortgages, cars, credit cards, and department store installment loans, a risky borrower was previously defined as somebody with a FICO credit score less than 620. That number is likely to change upwards as lenders become more intolerant of risk. Tomorrow’s risk for consumers is that a low FICO score may push them out of the credit economy altogether.
What is your credit score? If you don’t know your FICO score or credit score, it’s time to find out. Generally, credit scores are based on the extensive financial history that the three major credit reporting bureaus have already gathered on you from information provided to them by nearly everybody you have ever done business with involving the future payment of money. That probably includes your landlord and even the local library if you lost a book and didn’t pay for it quickly enough.
The higher your credit score the better. 850 is the maximum FICO score. The median FICO score in the USA is 723. Half the people are higher and half the people are lower. When money starts to get tight you want to be in the higher half.
You can get a free credit report from each of the three major credit reporting bureaus at annualcreditreport.com. You will have to pay for your credit score, however, which is conveniently (for them) not included in the free reports.
The absolute best time to get yourself educated about credit and money is right now.