The Crisis Revealed

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In the past, people did not worry about their credit as much as they do today. Before the crisis of credit fell upon us, threatening to drown many of us in a sea of uncertainty, the worst that could happen to you if you had bad credit was that your interest rate was very high. Perhaps you would end up in an adjustable rate or with a loan based on the stock market. But those days are done.

The new word is ‘no’. There are no ’special’ programs or exceptions, no options or promises. If you have bad credit, the answer is no. Ironically, if you have good credit however, your opportunities are more amazing than ever before. Interest rates are at an all time low, and the values of homes are so depreciated that you can snag yourself an amazing deal on your dream home. As long as you have a hefty down payment, patience, and a 700 credit score.

But who on earth has this beautiful credit score? And HOW? The answer is elusive, because the Fair Isaac Corporation wants it that way. I spent countless hours trying to unravel this mystery, and I came up with a couple of answers that many may find informative and beneficial. Most of this information comes directly from MyFico.com.

The most important piece of the pie is your payment history. For this reason, a late payment on major loan such as your home can make your score sink like the Titanic. It is important to attempt to have late payments removed from your credit history any way possible. Being consistently late on your mortgage payment can have your FICO drowning in the 500s in no time.

What you can do: Always be on time. If you know you will be paying late for any reason, contact the company and inform them so that they push back your due date or make an exception prior to actually being late. There are lenders that will allow you to pay late as long as you inform them in a timely manner. Another great way to raise your credit score is to keep a minimum balance and pay every month on time. Even if the monthly payment is only $10, paying on time every time raises your score exponentially as the account ages. In this way you are both benefiting your payment history and your credit history length.

Amounts owed is the next most important slice. Ideally, you owe only 20-30% maximum of total credit available. If you have a $1000 credit card, try to keep your balance below $300. Pay your minimum so that your score reflects consistancy. A big mistake a lot of consumers make is to close credit cards that are paid in full. Keeping cards with a zero balance open benefits you in two ways: it raises your credit available by lowering your amount owed versus available, and it helps you in credit history length as aforementioned.

Fifteen percent of your score is the length. The longer you have the same credit card the better. An American Express card that is fifteen years old and always current is like money in the bank. It shows lenders that you are responsible, trustworthy and accountable. Credit history of this length basically advertises your loyalty.

The type of credit used accounts for 10%. Types of credit include credit cards, retail accounts, installment loans, mortgage, consumer finance accounts, etc. Obviously a mortgage is calculated differently from a credit card. A mortgage cannot be considered for availability because of the way that a note is structured. Credit card balances fluctuate and are scored based on percentages, while a mortgage is based on on-time payments and length in years.

New credit is the last factor. The number of recently opened accounts the percentage of accounts that have been recently opened, by type of account, makes a big difference in your score. For example, someone who opens 5 credit cards at one time has a lower score than someone who already had 4 credit cards for many years and opens one new one. Also taken into consideration is the number of recent credit inquiries. Every time someone checks your credit with the purpose of attempting to issue you more credit it is reported on your profile and affects your score. The time since a recent account was opened or a credit inquiry was made also affects your credit slightly. Re-establishment of positive credit history following past payment problems becomes more and more relevant as the time goes by that you are current.

Education is the key to keeping a healthy credit report. No one factor determines your score, rather it is a culmination different factors that create an overall profile of you as a borrower. The scores are kept on a case by case basis and two people with very similar situations may have a drastic difference based on one or two items. One exception to the rule I have noticed, however, is married couples. Even though two unmarried people with identical credit overviews may have varying scores, with married couples there is usually very little difference.

Whether people realize it or not, their credit score affects every facet of their lives. Most likely, when you awake in the morning, you are in a mortgaged home. You take a shower and then drive your financed car to a job that may or may not have checked your credit prior to hiring you. After work you go to the grocery store and shop based on a budget calculated by how much money you have left after paying your mortgage, which depending on your interest rate determines how much cash you have. If you have a grown child in college with student loans, an equity line of credit or a credit card that you still owe $8000 to after that vacation last summer, you probably know exactly how much interest you pay on each of those accounts. You also know that your score has determined that rate.

The days of free credit for everyone are gone. We are actually back tracking to a time when people spent their entire lives nurturing their FICO score until that fateful day when they would buy their first home on a conventional fixed rate 30 year loan. There were no adjustable rates or sub-prime mortgages, it was good credit or continue renting. Perhaps it had seemed as though we had ‘evolved’ beyond demanding that only responsible, educated consumers get to buy homes on credit. But apperantly, that evolution has cost us financial stability as a nation. And perhaps the only way we will be able to crawl out of this mess is to learn from our predecessors, and start seeing credit as a responsibility, not a right. And if you need help making your credit score into something you live with, then give me a call.

As I was pursuing through some real estate news I became fascinated with the following phrase:

‘despite the efforts on the part of [insert institution here]…..’

And while my morbid fascinated is rarely sparked by such generic phrases, this particular one had me at a ‘duh’ moment.

I’ll tell you why. It doesn’t matter if Obama issues military-backed orders to all lending institutions in America and holds up Bank of America at knife point. It doesn’t matter if the banks bend over backward to send out overnight modifications to every home in the country. It doesn’t matter if a consumer stays on the phone day and night with the bank faxing and printing and obtaining. None of this matters.

The bottom line is many people simply DON’T HAVE MONEY! Even with a perfect loan workout and a 2% rate and stretching the loan to 40 years there are millions of Americans who are unemployed and simply cannot AFFORD their homes. So in my opinion, the question should not be WHY there are so many foreclosures but rather why the banks are not working harder to identify which borrowers CAN afford to stay in their homes? With the foreclosures actually dragging house values down, it is surprising to hear that banks will not workout many clients because they ‘make too much money’. The individuals who have decided that renting would be cheaper than staying in their devalued homes have chosen to walk away rather than continue to pay. Further destroying property values and adding even more fuel to the unemployment fire. Before this turns into a tirade, I’d just like to say that I don’t have the cure for our dilemma, but I do have a suggestion.

Expand loss mitigation departments. That’s it.

This may seem like a no brainer. Take all the people OUT of the ‘New Loan’ department and train them to modify. The banks had no problem calculating how many employees they needed to SELL loans, how difficult can it be to figure out how many people are needed to service the ones you have? You need people to answer the phone and punch in the consumer info. You need people in charge of mailing out applications for modification. People can be given the task of looking over documentation all day long and deciding who qualifies, not by some nit-picky system but in order of benefit to the economy. You need finance people to figure out the new terms, lawyers to write up documents, well you get the picture.

How people can sit around writing articles and speculate about why is beyond me. The ‘why” is clear- we are in this mess because credit lost its respect. In the past, people were responsible with credit because if they were not, they wouldn’t have any. As time went on and even 10 year olds could receive a credit card in the mail, everyone went nuts and started living way above their means using credit as their crutch. Loans were originated that should have never been signed and now we are all paying the price. So rather than focus on why, perhaps we should concentrate on how it can be fixed.

Eventually, the market will regulate itself. People with savings will purchase themselves a foreclosure and investors will do the same. Some neighborhoods will fall into disrepair and become abandoned. Many families will see hard times like they have never seen even in their worst nightmares. We have been through this before, and it will happen again, only this time we have cars and computers. The markets will shift, and slowly industry will begin to reform here rather than be outsourced overseas. In the meantime, what can a consumer do to avoid being one of the faceless masses on the brink of foreclosure? Diligence is key. Contact your bank over and over. If it gets tedious or frustrating, hire someone to harass them for you. And never, ever wonder ‘why’ again. Just focus on how it can be fixed, losing sleep over reasons is a waste of perfectly good sleep.

The big three are in big trouble. As I was trying to figure out what my article today would be about my mind started drifting to my awesome weekend. I took my kids to a museum and I bought my son a new Transformers blanket and pillow, which he adores. My boyfriend had never seen the Transformers movie so I made him sit through it. He went on a tangent making fun of Chevy for having helped to finance the movie. Every car in that movie is a GM, and the way it is looking, a couple of years from now it will be considered a history flick. One day our children will be watching this on a screen in class and marvel at the self-importance that this company exhibits.

I decided to break down the auto crisis into one long article for everyone to be able to understand, at a glance, what is going on. Let’s look at the ‘Big Three’ on a case by case basis.

Statistics

Employees: 20,000 Vehicles sold, 2008: 1.9 million Dealers: about 4300

Major U.S. brands: Ford, Murcury, Lincoln

USAToday:

DETROIT (AP) — Ford Motor (F) said Tuesday it plans to trim its number of dealerships in 18 metropolitan areas across the country, blaming sliding car and truck sales for the decision.

Employees: 54,000 Vehicles sold, 2008: 2.01 million Dealers: About 3,200

Major U.S. brands:  Chrysler, Dodge, Jeep

Chrysler, operating in Chapter 11 bankruptcy, tagged nearly 800 of its dealerships for termination.

Employees: 244,500 Vehicles sold, 2008: 8.35 million Dealers: 6,000

Major U.S. brands:  Buick, Cadillac, Chevrolet, GMC, HUMMER, Pontiac, Saab, Saturn

Businessweek.com:

General Motors (GM), facing a White House-imposed deadline to restructure or file for bankruptcy by June 1, notified 1,124 of its 6,200 dealers that the automaker intends to end their franchise agreements by late next year.

Effect on the General Public

1,100 dealerships across the country will be closing by October, with another 1,500 by 2010. I know my blog is about the credit crisis and home ownership but honestly, let’s look at the big picture. The first entity affected is the owner of the dealership. Following them is all the closers, finance professionals, mechanics, salesmen, buyers, human resources, and customer service agents. That alone could mean loss of jobs for hundreds of people, in just one dealership. After you multiply that by the number of dealerships, you are barely scratching the surface as to how serious this really is.

Once the dealerships close down, there is no reason to keep as many plants open. Therefore, all of those people are losing their jobs as well. Companies that produce the components that are then provided to these plants to assemble the vehicles lose business and have to cut down as well. A high percentage of the people who have just been laid off have homes and mortgages, and now will be not only unable to make their payments on time but also suffer the impossibility of finding a new job.

I found an article specifically targeting this problem on CNNMoney, and it shows exactly the kind of mess we are in for. The truth is that before the financial crisis came upon us, we didn’t see unemployment as something that we could not avoid. I remember hearing men yell at veterans on the street to ‘Get a job, you bum!’ and never thinking twice that perhaps this man in fact could not get a job even if he wanted to.

In fact, the number of unemployed people in the country is staggering because many of these people filing for unemployment benefits for the very first time are either highly educated or have been in their field for decades. There are people out there who gave 25 years of their lives to one the so-called ‘Big Three’ and now have no where to go.

Pensions and Retirement

The fall of the American auto industry is also indicative of what has happened to many peoples’ life investments and retirement plans. During its heyday people sat pretty on a wonderful pension plan after retiring from one of these automotive giants. So here’s my next reference (also BW):

Today corporate pension funds are badly depleted, for the same reason that worker-managed 401(k) plans have suffered: The underlying securities took huge market losses in 2008. Benefits consultant Watson Wyatt (WW) calculates that the 100 largest pension plans are now $217 billion in the red, with enough assets to cover 79% of their long-term promises, down from an overfunding of 109% just one year earlier. Their investment loss: $300 billion.

I decided to research a little bit about how pension plans work for your benefit.
The Pension Benefit Guaranty Corporation is a federal corporation created by the Employee Retirement Income Security Act of 1974. It currently protects the pensions of nearly 44 million American workers and retirees in more than 29,000 private single-employer and multi-employer defined benefit pension plans.  PBGC receives no funds from general tax revenues. Operations are financed by insurance premiums set by Congress and paid by sponsors of defined benefit plans, investment income, assets from pension plans trusteed by PBGC, and recoveries from the companies formerly responsible for the plans.

Basically that just means that in the event that these automakers crumble completely, this plan is in place to fund the pensions that remain. Due to the fact that this program is government funded as well, that is a very scary scenario. Where will these funds come from? And in the event that the PBGC does end up having to fund these pensions, chances are that the benefits will cut to accommodate, as much 25-29%. So far it does not look as though this will be necessary: YET, at least not with all companies. The Chrysler restructuring plan, which the United Auto Workers had helped to create, will remain in place and it is being presumed that the pensions will be transferred from the bankrupt company to the one that emerges, solvent, down the line. However, GM is teetering on the verge of perhaps the worst pension explosion in history, worse even than that of United Airlines which devastated the PBCG for almost  7.5 billion. The destruction of GM could leave the department liable for 13.5 billion, almost double that amount.

What About My Warranty!

Great Question, what about it? No I’m kidding. So far, from what I understand, the government had promised to back up all warranties so that consumers don’t shirk from purchasing a car from one of the affected companies. More information on warranties can be found here, however in addition to worrying about the warranties directly sold by the manufacturers, there is also the concern that dealership backed warranties are going under as well.

I hope my article was as informative to you as it was educational to me, I am amazed by the domino effect that this crisis is causing in our economy. I hope if you happen upon this article, you’ll put your two cents in.