Saturday, May 1, 2010

Managing Credit in the Post Credit Crunch Era

2010 marks a turning point in the world of consumer credit. We’ve just survived the worst credit environment since, well, ever. The CARD Act went into affect (most of it anyway) on in February 2010. And, lenders are actually starting to increase the amount of pre-approved mail they send to prospective cardholders. How can consumers benefit from this new environment? Where are the potholes? And lastly, what should we be doing with our credit scores?

Pothole #1 – Having Average FICO Scores is Good Enough. If you think this then you’re making a big mistake. Those of you who have FICO scores in the mid 600’s were considered golden 36 months ago. Today, you’re considered too risky and the credit market has largely passed you by. Conversely, if you have FICO scores above 720 AND are on the buyer’s side of the credit equation then you are in the catbird seat. Auto loans are at or near 0%. Mortgages are at or below 5%. Credit cards issued by credit unions are at or below 9.9%. It’s a great time to be a borrower but only if you have strong FICO scores. Shoot for 750 because that puts you in the best position.

Pothole #2 – Thinking the CARD Act Solved the Free Credit Report Scams. On Fair Isaac’s consumer website,, they take a jab at their newest “Biggest” nemesis, Experian. “U.S Gov’t brings common sense to “free credit report” false advertising” is front and center on their website. What they’re referring to is the new rule that requires companies that offer free credit reports to clearly state that it’s not the free credit report as required by Federal law. So, how did Experian get around this one? They will now charge you $1 for your “free” credit report. It still remains to be seen exactly how the Federal Trade Commission is going to address the continuous actions of Experian (who has already settled two financially meaningless lawsuits with the FTC). “Free” and “$1” are clearly not the same thing so the false advertising seems to continue. Regardless, consumers will still be enrolled for a monthly subscription to a credit monitoring service if you claim your $1, err, free credit report from so buyer beware.

Opportunity #1 – Better Credit Means More Leverage. You’ve heard to term “it’s a buyer’s market.” You’ve also heard the term “It’s a seller’s market.” Well, for the first time in almost three years it is now a buyer’s market in the consumer credit environment. But, it’s a buyer’s market only if you have good enough credit to deserve the very attractive rates offered by almost all lenders. If you’ve been putting off paying down credit card debt now may be the time as paying down credit card debt is the fastest way to significantly improve your credit scores.

Opportunity #2 – Short Selling Has Been Anointed as The Best Way to Dispose of a Bad Mortgage Loan. A short sale is when the lender takes less than the principal amount and considers the loan as being paid in full. A short sale is not clean from a credit perspective because it is reported as either a charge off or a settlement, both of which are considered very negative by the FICO scoring system. But, Fannie Mae will allow you to get a mortgage within two years if you’ve chosen a short sale over a foreclosure.

Pothole #3 – Beware of Loan Modifications. Loan modifications are a relatively new phenomenon thanks to the mortgage meltdown. Homeowners who have some sort of hardship might be able to convince their lender to lower the interest rate so much that the payment becomes affordable and allows them to avoid foreclosure. The problem with loan modifications is you are not guaranteed the modification. And, it takes many months for large mortgage lenders to decide whether or not you will qualify. During this time they are asking that you pay a lower amount. This is called the “trial period.” This is reported as a rolling late payment to the credit bureaus, which obviously can damage your credit scores. And, after all is said and done, you might find yourself without a modified loan but with many months of late payments, which are not removed.

Pothole #4 – The Authorized User Strategy Might Backfire. For many years consumers have used the authorized user strategy to build, rebuild and/or improve their credit. The theory, which was accurate, was if you could add an account with a stellar payment history and a large credit limit to your credit file simply by being added as an authorized user on an account belonging to another person, perhaps a parent. Since the authorized user doesn’t have contractual liability the cardholder isn’t responsible for the payments. If the primary cardholder became delinquent then you would simply have your name removed from the account and it would be removed from your credit reports. The problem with the strategy today is that at least one of the credit bureaus, Equifax, won’t remove the account from your credit reports. In fact they are responding to dispute letters with the following, “As an authorized user, you may be liable for any/all activities on this account.” The issue is the word “may.” It’s my belief that a credit bureau can’t maintain information on your file that it simply believes “may” be your responsibility. This one will likely play itself out in court when the class action set gets wind of this.

It’s important to keep in mind that the world of consumer credit is dynamic, constantly changing. Credit scores will likely change, lenders will change their standards, and credit bureaus will change their policies. These observations are as of early 2010 and will eventually become outdated, perhaps even by the end of the year. Stay tuned.

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