Even a small dip now can hurt you
Turbulence in the economy and the financial industry has probably affected your creditworthiness — even if you haven’t lost your job or missed a single loan payment. Some lenders have taken steps that lowered their customers’ credit scores — even though many of those customers never did anything wrong. The industry’s changes may have made it harder for you to borrow money for a car or house, obtain the best credit cards and even get the best insurance terms.
Here’s what you need to know about your creditworthiness so that you are in control of your borrowing options. You may be surprised by some of the ways that your credit score can be hurt — and how a lower score can hurt you…
HIGHER BAR FOR LOW RATES
In 2007, a credit score of 680 (out of 850) would have qualified a borrower for the most attractive credit card, mortgage and car-loan terms. Today lenders consider that same 680 score closer to subprime than grade A.
Interest rates currently are very low by historical standards — but those attractive rates are available only to borrowers with extremely high credit scores…
Mortgage rates. Rates as low as 4.6% were available on 30-year fixed mortgages as of late May — but only to borrowers with credit scores of at least 760. A once-respectable score of 620 is more likely to receive a rate of 6.2%. That’s a difference of around $90,000 over the life of a $250,000 30-year mortgage.
Auto loans. Rates as low as 5.4% currently are available on 48-month new-car loans from independent lenders. Dealership financing departments occasionally feature rates as low as 0%, but only buyers with credit scores of at least 720 receive these terms. With a score of 680, the best available interest rate from independent lenders is likely to shoot up to 8.9% — resulting in more than $1,500 in extra payments on a $20,000 four-year car loan.
Credit cards. Aside from short-term teaser rates, the lowest interest rates currently offered by credit card issuers are around 7.9%. You’ll need a credit score of at least 740 to be approved for those rates, however. If your score is closer to 680, you’ll be lucky to find a 14.9% rate — and you might not do better than 19.9%. That’s an extra $700 to $1,200 per year for each $10,000 in revolving debt.
Insurance. Many auto insurance and homeowners insurance companies now check credit scores of policyholders and applicants. A low score could mean higher premiums or a rejected application — even for those who have never made an insurance claim. Also, utility companies check credit scores to determine security deposit requirements.
HOW SCORES GET HURT
Lower credit limits: Credit card issuers have been slashing credit limits even for responsible cardholders, not just for those who miss payments. Lower limits don’t just mean less spending power — they can result in a substantially lower credit score. How? When credit limits fall, the percentage of available credit used rises, even if your spending does not increase. “Credit-utilization ratio” is a crucial factor in credit scoring.
Example: A man with one credit card uses just 5% of his card’s available credit line. He has an excellent credit score of 780. If the man’s card issuer slashes his credit limit by 50%, then his credit-utilization ratio increases sharply and his credit score could plummet all the way to 650 — subprime — even though this man has done nothing wrong.
Despite the recent credit card industry reforms, card issuers are not required to warn customers when their credit limits are lowered.
If you have many credit cards, one card issuer slashing one credit limit might have only a small effect on your credit score — but cuts on credit limits often snowball. When your other lenders see that your credit limit and credit score have fallen, they might get jittery and cut the credit limits on their cards, too.
Strategy for fixing the problem: Check your credit card account statements each time you pay your bills. If the credit limit on any of your cards is lowered, ask the lender to reconsider the decision. Also, immediately request increases from other lenders, and do everything possible to pay down all of your cards.
To maximize this component of your credit score, you must use less than 10% of your overall credit limit. Try to raise your limit high enough so that you rarely exceed this percentage, even if that means hanging on to or adding credit cards that you rarely use. (Debit cards have no effect on your score because they automatically draw on your accounts to pay expenses.)
Mortgage arrangements: Many people don’t realize that some of the alternatives to foreclosure can damage their credit scores just as much as foreclosure itself would. These include…
Selling the home through a short sale. With this arrangement, the lender agrees to accept less than the full amount owed on the home.
Deed-in-lieu of foreclosure. Here, the property is handed over to the lender to satisfy the mortgage. There is no foreclosure proceeding, and the home owner is released from any further financial obligations.
Either of these actions is likely to result in a drop of 100 to 200 points or more to the home owner’s credit score — just as a foreclosure would.
Strategy for fixing the problem: There is no quick way to erase from a credit report the negative effect of a mortgage gone bad. It sometimes is possible to return a credit score to respectability, however. Pay off all of your credit cards until you are using less than 10% of your available credit limit. This sometimes adds as many points to the credit score as a mortgage problem subtracts.