According to a recent FICO study, over one-fourth (25.5%) of Americans have poor credit. Nearly 43.4 million people now have a credit score of 599 or below.
When you go to the grocery store or a ballgame, look around–one in four people around you have serious financial problems.
Expect that number to grow as households continue to struggle through unemployment, credit card debt and foreclosures.
How Did We Get Here?
People don’t get into financial problems overnight. It took years of overspending, overlending, and poor regulating to create these problems.
Lenders, and even the government, share some of the blame.
The government helped open the door for higher rates and fees in 1978. At that time, a majority of states had usury laws that capped interest rates on credit cards, usually at about 18%.
That year, a ruling in Marquette National Bank vs. First of Omaha Service Corp held that national banks could charge credit card customers the highest interest rate allowed in the
bank’s home state, instead of the customer’s home state.
Taking advantage of this new ruling, many major banks moved to states such as South Dakota and Delaware since those states had no usury limits on interest rates and they could even export these rates to the other states.
In the early 1990’s, credit card issuers advanced beyond one-rate-fits-all offers and used credit scores and financial data to develop pricing and credit strategies. They set rates and limits based on computer assessments of an individual’s risk of default–the higher the risk, the higher the interest rate.
This new data led to innovations such as increased credit limits and decreased minimum payments.
“These new, advanced risk assessments created new opportunities to lend to people who were a higher risk including people who should not have had credit. The new loans and higher credit limits were profitable for banks, but made the problem worse for the borrowers,” says Bill Hardekopf, CEO of LowCards.com and author of The Credit Card Guidebook.
In 1996, a Supreme Court ruling (Smiley vs. Citibank) ruled that fees should be included with the balance, and could determined by what the bank’s home state would allow.
This ruling allowed issuers to charge more for fees as well as create new fees, such as over-the-limit fees. This ruling also opened the door for punitive practices like the Universal
The days of loose lending for mortgages and credit cards, high rates and fees, second mortgages and borrowing beyond more than you could repay couldn’t last forever. The crash occurred in 2008 and caused tremendous losses for borrowers and lenders.
Banks and credit card issuers responded by slamming the brakes on lending. They cut credit lines and increased interest rates. Reduced credit limits hurt borrowers’ credit scores, and higher interest rates made it harder for them to pay down their balance.
Credit card issuers reacted strongly and quickly to protect themselves, but 25% of Americans are practically banned from inexpensive credit at the time they need it. The tightened lending policies shuts off these consumers from many financial options.
Actions Causing Lower Credit Scores
* Debt-to-payment ratio increases. This happens when you add to your outstanding balance, moving you closer to the credit limit; or when the issuer reduces your credit limit. A higher debt-to-credit ratio is considered a higher risk and can result in a drop of about 20 points
* Late payment. Some credit experts believe a few late payments on a credit card or other loans can lower your score by as much as 100 points if you have a great score, or 80 points for someone with an average score. Making payments on time is a big step toward improving your credit score.
* Defaulting on a loan or a foreclosure may lower a score by as much as 200 points.
Here’s the basic breakdown of how long different types of negative information will remain on your credit report:
Late payments: seven years.
Bankruptcies: seven years (Chapter 13) or ten years (Chapter 7).
Foreclosures: seven years.
Collections: Approximately seven years, depending on the age of the debt being collected.
Public Record: Generally seven years, although unpaid tax liens can remain indefinitely.
The good news is that the older the negative item, the less impact it will have on your FICO score. A collection that is five years old will hurt much less than a collection that is five months old.
A subprime credit score is just a number. It doesn’t tell the individual story or reasons that a person gets into financial trouble. It doesn’t tell of the stress caused by higher loan rates or increased insurance premiums because your credit score says you are a high risk. But lenders, insurers and even employers will make judgments and decisions about you based on that number.
Car loans, mortgages, credit card loans–all of these cost more when you have a subprime credit score. This puts additional strain on a budget that is already breaking.
“When consumers have made poor financial choices and have damaged their credit score, they are on their own to fix it. There is no federal bailout or TARP fund that will rescue them,” says Hardekopf.
Ways to Raise Your Credit Score
It’s important to note that raising your FICO credit score is a bit like losing weight: it takes time and there is no quick fix.
Here are a few tips for raising your credit score:
* Get a copy of your credit report from all three credit agencies. U.S. residents are entitled to one free copy of their credit report from each credit reporting agency once every 12 months.
This information is found by calling 1-877-322-8228 or at AnnualCreditReport.com. If any of the information on a report is incorrect, contact the agency to correct it.
Incorrect information should be corrected or removed within ten to thirty days, and doing so may give your score a quick boost. Your credit score is usually not shown on the free annual credit report.
There are paid options that will allow you to see your credit score.
* Pay your bills on time. This is the single most important factor in your credit score. Even if you only pay the minimum, pay your bills on time.
Late and missed payments can quickly lower your credit score.
* Pay off your debt. High balances and high debt ratios drag down credit scores. Your debt balance should be less than 35% of your available credit.
If you have a good payment history, contact your creditors and ask for lower interest rates. Then use what you saved in interest to pay down your
* Build a long-term relationship with the accounts you have. A long history of good payments on a car loan, a mortgage, or a credit card increases your credit score. Keep older credit card accounts open, even if you are not using them, because you are rewarded for a long, positive credit history. If you review your credit report and discover that you have many accounts that you no longer use, close the newest ones first.
* Limit your credit applications. Too many new accounts can lower your credit score. Each time you apply for a loan, the application shows up on your credit report. A significant increase in inquiries signals that you are desperate for money and are a credit risk. The exception is shopping for a mortgage or a car loan, as multiple inquiries for the same purpose in a reasonable period are considered a single inquiry.
* Get a checking and a savings account.
* Do not co-sign for a loan for someone else. This shows up on your credit report, and a missed payment or a maxed out credit card by the other person will affect your credit score.
*If you can’t pay your bills, contact your creditor or see a legitimate credit counselor. The National Foundation for Credit Counselors (http://www.nfcc.org/), a not-for-profit organization, can give counseling and help you put together a debt management plan.
New Legal Protections
Under the new financial reform there is now a law dictating that a lender is legally responsible for assessing a borrower’s ability to pay.
Lenders will have to verify borrower income to make a loan.
Additional consumer protections and regulations include: free credit scores for those denied credit or offered only higher rates because of negatives on their credit report; brokers can not receive incentives to steer homebuyers into pricier loans; institutions that lend irresponsibly will be penalized.
LowCards.com ( http://www.lowcards.com ) simplifies the confusion of shopping for credit cards. It is a free, independent website that helps consumers easily compare credit cards in a variety of categories such as lowest rates, rewards, rebates, balance transfers and lowest introductory rates. It also gives an unbiased ranking and review for each card. The
LowCards.com Complete Credit Card Index ( http://www.lowcards.com/CreditCardIndex.aspx ) is the most objective and comprehensive resource on the Internet which allows consumers to compare rates for over 1000 credit cards offered in this country. Created by Hampton & Associates, the company has been analyzing the credit card industry and supplying objective websites on various consumer expenses for ten years.
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