|
||||||||||
In a sobering reminder that the long-term economic downturn is taking its toll, more Americans are seeing their credit scores drop below the levels considered necessary to qualify for mortgages, credit cards, and other important lending products. According to the Associated Press, today one out of every four Americans have FICO scores that fall below 600, up from 15 percent of Americans only a few years back.
FICO scores are used by lenders such as car loan, mortgage, and credit card companies to determine a person’s credit worthiness. Created by Fair Isaac, the company behind FICO scores, the scores put a numerical value on the degree of risk involved in extending credit to a consumer. FICO scores range from 300-800, with anything below 620 currently considered “bad credit,” i.e. high risk. There are other types of credit scores as well, but FICO scores are the most commonly used. All credit scores are based on pretty much the same features, including a consumer’s credit history, payment record, debt-to-available credit, and credit mix.
On the background of recent economic events, the rise in people with bad credit scores hardly comes as a surprise: record foreclosures, high unemployment, and drops in property values have swept many consumers into a downward credit spiral. People struggling financially often are forced to turn to credit cards and other types of loans to make ends meet. Unfortunately, as credit card balances increase and meeting payments becomes increasingly difficult, credit scores quickly head south.
Approximately 43 million Americans now have credit scores below 600, cutting them off from an important part of the economy and seriously limiting their financial prospects. Conventional loans require a score in the neighborhood of 700, and even for the more forgiving mortgage loans backed by the Federal Housing Administration, consumers need a score of at least 620 to qualify. People whose credit scores have plummeted are also excluded from important economic services most people take for granted, such as financing a car purchase or getting a credit card with reasonable terms.
Whether motivated by the markets or forced out of necessity, more and more consumers are making an effort to live tightly within their means and pay down credit card debt. Unfortunately, pulling a credit score out of the deep end isn’t a quick and easy job: for the worst credit score blemishes, such as bankruptcy or credit card defaults, it takes seven years to fix the bad credit, even once all the issues have been taken care of. For minor issues, such as late payments or high credit card balances, however, credit scores can be increased much faster, once the underlying issue is addressed.
Consumers whose credit scores have dropped to risky lows might want to consider turning to credit counseling—a service which is often available for free. According to experts, consumers who adopt a credit counseling debt-management plan can be back in the black within five years. Those who want an even more aggressive course of action can also work with a credit repair company who, for a sizable fee, will negotiate more heavily with lenders.
In general, when it comes to credit scores, an ounce of prevention is worth a pound of cure. Take these simple precautions to make sure that your credit score never heads so far south that it becomes a financial liability:
- Always pay all bills on time, particularly credit card bills and mortgage payments; your payment history makes up a full 35 percent of your FICO score.
- Keep credit card balances low in relation to the credit limit, i.e. below 30 percent and ideally around 10 percent. The debt-to-available-credit ratio across all credit card accounts makes up 30 percent of FICO scores;
- Keep a mix of different types of credit;
- Limit applications for new credit to a minimum, ideally not more than once a year;
- Keep old credit accounts open, even if you don’t use them.
See here for more ways to improve your credit score.
