On Wednesday July 21, 2010 President Obama signed a massive financial overhaul which included putting The FACS Act into law. The FACS Act is the Fair Access To Credit Scores and is a major win for consumers. The FACS Act guarantees that consumers who are denied anything based on their credit scores, including getting a better interest rate, will get a copy of the actual score that was used to make the credit decision.
While the implementation date of the free score disclosure rule is still to be determined, it will not come a moment too soon. FICO™ scores have plummeted more over the past 3 years than they have over the previous 17 years due to the mortgage meltdown and a 10% unemployment rate. This means a higher percentage of credit applications will be denied because not only have scores decreased, but underwriting standards have increased further separating applicants from credit approvals.
FICO™ scores have been around since 1989 and their distribution has remained relatively unchanged since their inception. The two primary reasons for this are the size of the credit bureau databases which is currently 200 million credit files, and the fact that we have not seen the confluence of so many significantly influential economic events.
Until the beginning of the recession, roughly 15% of the population that had a score, had one or more below 600. As of April 2010, 25.5% of consumers have scores below 600. This is an increase from 30 million to 51 million. More importantly is the percentage of consumers who score below 650 has gone from 27% to 35%. This means at least 70 million consumers have FICO™ scores below 650 and are now considered either sub-prime borrowers or at the very least a highly elevated credit risk.
The question now becomes what will these people do now that their scores are so low? Some believe that the dramatic plunge of FICO™ scores is because of excessive credit card debt which could not be further from the truth. Credit card debt does not cause your FICO™ scores to plummet into the sub 600 region. Further, this kind of credit degradation is caused by negative credit events hitting a consumers credit file. Bankruptcy, collections, late payments, charge offs, foreclosures, short sales, settlements, etc. are the types of events that cause such score damage. It is these types of events that continue to escalate at warp speed causing the overall consumer credit score averages to plummet below the 600 mark.
Unfortunately, these negative events will remain on credit files for the allowed statute of limitations, which is 7 to 10 years depending on the event. This means the new lower score distribution will remain as such for the foreseeable future. It also means higher interest rates, lower credit limits, more expensive insurance and difficulty in getting employment as long as your prospective employer relies to some extent on credit screening.
With unemployment at 10% and under-employment at or above 16%, fewer consumers will be able to pay their way out of poor credit. This will require an alternative strategy that depends largely on avoiding credit while you put time between yourself and the negative credit events that are causing the lower scores. Normally, this is not a wise strategy because FICO™ scores like to see new and healthy credit reporting monthly to help offset the damage being caused by older negative items. The problem is that the price of using credit with scores so low is simply too expensive.
This could also mean that bankruptcy could become the best choice as it will protect you from your creditors and get you largely out of debt, assuming you qualify for a chapter 7 rather than a chapter 13. Bankruptcy will remain on your credit reports for 10 years from the filing date however, it will wipe away the debt owed to collection agencies and your current creditors. This will also prevent additional negative information from hitting your credit files while you are trying to dig your way out of the FICO™ basement.
The news is not all good for those of you who have maintained or achieved elite FICO™ scores above 800 at the same time so many have seen their scores drop to all time lows. Lenders are not only looking for better credit risk borrowers, but they are also looking for customers who will generate revenue. Unfortunately, more and more lenders are recognizing the fact that consumers with extraordinary FICO™ scores are also less likely to depend on credit and do things like maintain revolving balances from one month to the next.
This has resulted in lenders actually declining applicants if their scores are too high. This will give the impression that lenders do not know what they are doing and that consumers are being treated unfairly. In a bit of ironic humor, consumers who are declined because of FICO™ scores being too high will also get to see their scores because of the denial. Can you imagine getting an adverse action letter from a lender stating that you were denied because of your FICO™ score just to find out that your FICO™ score is 825? The world of credit is not without humor.
Thank you for reading this months edition of the RE Credit Repair, LLC newsletter.
