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Wednesday, Dec. 17, 2008

Credit Crunch Brings FICO Into Focus Can You

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Contrary to the headlines, banks are still lending money. As long as you have excellent credit, your ability to secure a loan or a line of credit is largely immune to the current economic meltdown that has turned the nation’s top lenders into wards of the state.

Those with less than excellent credit face higher interest rates, shorter terms and larger down payments, a credit calculus made possible by FICO.

The Fair Isaac Corporation—FICO—is a publicly traded company that compiles and provides consumer credit scores. The scores range from 300 (poor) to 850 (perfect), and largely determine who qualifies for a loan and at what terms.

Just six months ago a FICO score as low as 630 was considered excellent, and entitled you to the same terms as a person with a 760 score. Loans made to those with lower scores were dubbed “subprime” by the media and, in the days of low interest rates, were easily secured.

But those days are gone. Today’s subprime borrowers are shut out of the lending market, though some buyers may secure a government guaranteed loan. “The requirements these days are more strict,” said Doug Lenski, owner of Wholesale Mortgage Services of Wisconsin. “Today, a borrower with a 630 score may need to pay three points to get the same rate as the 740 borrower.”

In mortgage-speak, a point is equal to 1% of the total loan value.

Lenski said mortgage lenders recently began using a tiered ranking system, based on FICO scores in 20-point increments. “A 740 score, along with 20% down, will get you the very best terms,” Lenski said. “Nothing has really changed for those with good credit.”

A score of 720 to 739 will result in a slightly higher rate. Score 700 to 719 and your rate bumps up another notch. “If the borrower with the 740 score is paying 5.5%, then another borrower with a 640 could be paying 6.5%,” Lenski said.

Your credit score also follows you into the car showroom, where a 100-point spread will determine your interest rate, the length of the loan and how much money you need to put down for your wheels. “A borrower with a 640 score might be required to pay a 50% down payment to secure the loan, and the term might be cut from 65 months to 60,” said Dan Drinkwine, finance manager for Hall Chevrolet.

Drinkwine characterizes credit scores over 700 as an A, 670 to 700 as a B, and 640 to 670 as a C. The median credit score in the United States is about 700, meaning half of consumers have scores above that number, and half below. “We can finance a car for a C,” he said.

Kathryn Crumpton, manager at Consumer Credit Counseling Service of Greater Milwaukee, said knowing one’s credit score has always been important, “but especially so now with changes in the credit market, and the overall downturn in the economy.”

Still, many if not most people aren’t familiar with FICO scoring, much less their own credit report. “When I give talks around the community, I’ll ask a roomful of people how many know their own scores,” Crumpton said. “About half raise their hands.”

The next New Economy will be published in the Dec. 25 issue of the Shepherd. 


Definition of the Week

Keynesian: A branch of economics, based, often loosely, on the ideas of John Maynard Keynes, characterized by a belief in active government and suspicion of market outcomes. (Source: Economist.com)