Debt Settlement Company Overpromises

debt_consolidation

Picture that scary in-between financial moment, a kind of knife-edge living, when you have too much high-interest debt to pay off in any reasonable amount of time, but not so much debt that bankruptcy is necessary or inevitable. What do you do?

A friend of mine, who would like to be known just as D, received an offer in the mail from Americor Financial Services, promising a new $27,000 line of credit.

D pays all his debt on time, but it’s expensive. He anticipates additional expenditures in the months to come. D would like more available credit. D called Americor to learn more about that line. After offering up details over the phone on his financial situation, including how much debt he currently pays on, the representative described a plan. Begin paying Americor monthly, approximately $500 less than he currently pays, and cease paying on the rest of his high-interest credit cards.

After 4 to 6 months, the representative told him, Americor will be able to negotiate from a position of strength with his banks. The representative practically guaranteed that the banks would accept a negotiated settlement for 50 percent of what D owed.

Perhaps the most intriguing part of the Americor representative’s pitch to my friend is that Americor promised that his credit rating – which is currently strong — would only temporarily dip, for about six months. After that, it would bounce back quickly. In addition, the debts would be reported to the credit bureaus as “paid in full,” even if reduced to 50 cents on the dollar. I call BS on that part.

What about that original $27,000 line of credit promised in the mailing, my friend D asked the representative? That line, it turns out, is only available approximately 16 months after enrolling in Americor’s program, or once his outstanding debt has been reduced by 50 percent. The line of credit would cost 18 percent annually. The Americor representative assured D his credit would be good enough to obtain a better rate elsewhere, if he wanted to, at something like 8 percent.

That of course, would depend on having great credit 16 months later. Which, again, I doubt.

D told me,

“No equivocating, they promised me that the old creditors would be happy and eager to extend me new credit at the end of the process.”

Wouldn’t his score go down, D asked Americor, repeatedly? D told me, “He said it would just go down in the beginning, but that sometimes you have to take one step back before taking two steps forward.”

The Americor representative told him “people do this all the time.”

In fact, much of this pitch sounded like BS to me. To give Americor the benefit of the doubt, banks do settle for less than the full amount owed on debts that have gone delinquent, especially perhaps over 90 days. But the claims about a quick bounce back in credit score did not pass the smell test.

I reached Dwight Flenniken III, Chief Marketing Officer for Americor, on the phone. I presented to him my two main doubts. First, not paying debts for 90 days would absolutely wreck my friend’s strong credit. Second, his credit bouncing back in a year and a half just didn’t make any sense.

Credit card companies care a tremendous amount about both timely payments and full payments. They distinguish between 30-, 60-, and 90-days late on payments as increasingly severe problems. Any 90-days late payment has a lasting effect on your score. Accounts in collections and accounts not paid in full stay as negative marks on your credit for years.

Talking with Flenniken cleared up my confusion, at least as it would apply to my friend D.

The first reason is that Americor’s typical client is in a lot worse shape, credit-wise, than my friend.

“People don’t come to us until their credit is wrecked. Most of our consumers have between a 540 and 600 FICO,”

Flenniken clarified. Starting from a low FICO, Flenniken and I both agreed, a downward dip isn’t very consequential.

Since D’s credit is in the high 600s, close to Prime, his score would fall a lot further than the typical Americor client. I think the original representative painted an overly positive picture of the consequences for my friend, in terms of “one step back and then two steps forward.” Flenniken agreed D might have better options than Americor.

FICO_unused_creditThe second factor involves a little game – my word, not Flenniken’s – that Americor plays with the credit bureaus. They begin by reporting a new open line of credit with the debtor within a few months of enrollment in their program. A client like my friend, however, would not be able to actually access the line of credit until lots of conditions had been met, often not until that 16 month mark.

The thing you have to know about this trick is that 30 percent of what makes up a FICO score is what’s known as “credit utilization,” meaning the portion of your lines of credit that you’ve drawn upon.

A new $27,000 line reported on my friend’s credit from Americor – that he can’t actually access for another year – would act as a significant buoy to his credit score through improving his “credit utilization” score. That buoy could partially counterbalance the effect of delinquencies, especially for someone starting with very low credit. The fact that this new credit line is in theory only – again, not accessible for over a year – is why I consider this a bit of credit-scoring legerdemain 1 that Americor plays. They’ve kind of hacked the FICO score.

On the knife’s edge, there’s a place for struggling through, sucking it up, and knocking out one’s debts the slow, hard way. There’s also a place for a fresh start through bankruptcy, or hiring a debtor’s attorney to negotiate for you, or even working with a debt negotiation company like Americor. A debt settlement company over-promising an “easy way” out of too much debt without hurting your credit, however, is just setting you up for disappointment.

D tells me he will not be going forward with Americor Financial Services.

 

A version of this post ran in the San Antonio Express News and Houston Chronicle

 

Please see related post:

The Power of a Debtor’s Attorney in TX

FICO Scores – Part I 

FICO Scores – Part 2 

 

 

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  1. Dare I say, ‘prestidigitation?’

Ask an Ex-Banker: Freelancer Homebuyer?

Editor’s Note: This post first appeared on the website Make Change as an advice column “It’s Complicated,” which is in the spirit of my occasional “Ask an Ex-Banker” posts. If you have personal finance questions for “It’s Complicated” or “Ask an Ex-Banker,” send me a note!

  homebuyer

Dear Its Complicated:

I’m a single fulltime freelancer looking to buy my first house. I’ve read a lot about how daunting the process can be for freelancers and now I’m worried and confused about what to expect.

While I don’t have a corporate gig, I do have nearly a decade freelancing in my industry with a steady income stream. I do have some debt I could pay off before applying for a home loan and am paying off last year’s taxes. Otherwise, I have a solid rental history and enough saved up to put 20 percent down on a modest home in my area.

Given that, what should I be doing now to secure a home loan in six to 12-months? When I’m ready to apply, what should I be prepared for when it comes to proving my income or work status? Finally, how worried should I be about the IRS payment plan and my small amount of debt?

Any guidance would be appreciated!

Dear Freelancer,

Congratulations on your imminent leap into homeownership.

You already anticipate that being a freelancer will make getting your mortgage a difficult process. Sadly, I agree. You should expect the worst. And then realize it will be even harder than that. By the end it will seem like they asked for everything except blood samples and your ability to count backwards from 100 by 7s. It’s super-annoying!

And so, may your home-buying mantra be borrowed from recent kerfuffles in the US Senate: #NeverthelessShePersisted.

Done right, homeownership can be the most powerful tool for building long-term wealth available to the middle class. (Emphasis on “done right.”)

In order of importance, your home purchase journey starts with spending a little bit of money this week to acquire your credit scores and reports. Those results will dictate what you do in step two, which is to get “financially fit” in the coming months. Third, I’ll describe how you can—and should—take proactive steps with a mortgage banker or broker, even before shopping for your house.

Step one: Credit report and score

Your first step is to order your credit reports and credit scores from each of the three credit bureaus, Experian, Equifax, and TransUnion. Each bureau offers a version of a 3-in-1 report combining all your information for about $45. You could also purchase your reports and scores separately for around $15 a pop. And while you could stick to one bureau’s credit report and score, keep in mind that reports can vary widely from each bureau. If you don’t check out all three, you could miss an error or negative information only reported by one bureau.

fico_scoreAlternatively, by law, you’re entitled to a free copy of your credit reports from all three credit bureaus once per year through AnnualCreditReports.com. But this only gives you the reports, and you’ll have to order your credit scores separately. Which is annoying. So skip it, and pay to get your score.

I’ll explain the importance of this step in a moment, but first, a few words of caution about buying your report and score. These three credit bureau’s websites seem to purposefully and maddeningly muddle your attempt to buy your report and score just once. Their websites steer you toward some “monthly credit monitoring,” at much more then $15 over time. #Resist all that nonsense. Also, steer clear of “free credit report” offers you see online because that does not include your actual numerical score. And finally, be leery of any site offering free credit scores or credit monitoring. Many of these sites simply estimate your score, and you need your true FICO score to move on to steps two and three. (For more on FICO scores, may I suggest Part 1 and Part 2 of an explainer by me?)

A big part of your future mortgage lender’s decision will ride on this information. You need to know how they will view you. Applying for a mortgage without knowing your score would be akin to applying to college without knowing your own SAT scores. You’d be flying blind and would probably apply to the wrong places. Like the SAT for college admissions offices, your FICO score is the sorting mechanism that mortgage lenders use to figure out how to treat your application.

Generally, if you score a 720 or above, every mortgage lender in the country will welcome your application with open arms and its best terms and rates. Your application will be directed to a “prime” mortgage. If you score in the mid-600s to 720, you can still qualify for a normal-ish mortgage, but expect the cost to borrow money to be higher, possibly even significantly higher. If you score a mid-600s or below, you will be relegated to a “sub-prime” mortgage with either a punitively high interest rate or a low teaser interest rate that will adjust upward and likely become unaffordable later.

Of course, all of the above is complicated somewhat by your freelancer status. Even if you have sterling credit, read step three carefully for information about income verification.

Step two: Getting financially fit

Reasonable people could disagree on the following, but I would counsel most people with sub-prime scores to wait on buying a house. You specifically mentioned outstanding debt as well as an IRS agreement in your financial profile. A payment plan with the IRS generally won’t appear on your credit report unless you’ve defaulted on the monthly payments. If you have missed payments, or the IRS has placed a lien against you, this could push your credit score below prime. Carrying debt can also drag your score down, especially if you have late payments or have had any debt assigned to collection agencies in recent years.

subprimeBorrowing on a sub-prime mortgage will add 5 to 10 percentage points to the cost of your loan, or let’s say an initial $10,000 to $20,000 per year on even a small $200,000 mortgage. Just five years of that extra cost and you’re $50,000 to $100,000 poorer than you need to be. A better plan would be to settle all your outstanding debt problems in the next year. Later, with collections or tax liens in the rear-view mirror, the passage of time will heal your credit score. Waiting a year or two to build your FICO score up before buying the house will leave you wealthier in the long run.

If you’re already in the prime range, then you can accelerate your timeline. You mentioned worrying about your IRS payment plan and small amount of debt. If the IRS imposed penalties on you in the past, or you are subject to an IRS lien, certainly I’d recommend sorting that out before taking on the obligation of a large mortgage. If you have a good score, however, that indicates to me that you’re currently paying all tax plans and debts as agreed, without penalties. In that case, they are unlikely to inhibit getting a mortgage.

Mortgage lenders expect borrowers to already have some debts when they apply to a mortgage— whether student loans, car loans, or credit card debt—so a small amount of debt won’t deter them. You might feel better being debt-free, but it’s not necessary in order to get approved for most mortgages. The way the bank views your small amount of debt is like this: $10,000 in cash in the bank with $5,000 in debt gives you a net worth of $5,000. From the lender’s perspective that’s nearly the same exact position as if you had $5,000 in cash and zero debts. Banks won’t sweat the small debts.

Step three: Getting pro-active with a mortgage broker or lender

Before you shop for your house, every realtor will recommend you get pre-approved for a loan from a mortgage lender, for good reason. That pre-approval, including the maximum amount you can borrow, let’s you make an offer on a house with the confidence that you can actually buy it, and that makes you a much more attractive buyer. Without that pre-approval, you could expect realtors and sellers to take you less seriously when you make an offer to purchase a home. During the pre-approval process, you will present your assets, income, and employment, as well as debts. You will specifically want to explain your freelancer status to whoever works on getting your pre-approval.

preapprovedSince your income has been steady for a few years you should be able to get pre-approved. But expect that the lender, when it comes time to actually extend you a loan, will ask extremely invasive questions about your work and income . One to two years of federal tax returns will be the start of their inquiry. I can’t anticipate all of the ways a bank will try to vet your consistency of income, but be prepared to prove out anything you claimed as income.

Here’s an extreme example, courtesy of the editor of Make Change who bought a home with her freelancer husband in 2012, right after she’d transitioned from freelance work to a fulltime job: a few years’ worth of statements from every bank account they held individually and jointly, a letter from her new boss stating he anticipated her working there for the long-term (#awkward), verifying every check deposited for the past several months, including personal gifts in amounts of $50 or less. And that wasn’t everything, in total, she turned over two banker’s boxes worth of documents to her lender, and that was with a credit score in the prime range. Just remember to deep breathe your house buying mantra #NeverthelessShePersisted.”

Thankfully, the further out from the recession we get, the fewer of these burdensome verifications seem to be required. Still, it’s best to be over-prepared, even if it’s about as fun as a lumbar puncture. Hopefully it will all be worth it. Good luck!

 

A version of this “Ask an Ex-Banker” post appeared as a post for a semi-regular advice column “It’s Complicated” in the personal finance website Make Change.

Please see related posts:

FICO Scores explained Part 1

FICO Scores explained Part 2

Rent v. Buy – The Simplest Answer

Homebuying Part 1

Homebuying Part 2

Homebuying Part 3

 

 

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FICO Part II – When To Ignore It, And Why Its Awesome

fico_scoresLast week I wrote about the personal credit score, used by virtually all lenders in this country, known as FICO.

But I know there are some of you who you can and should ignore your FICO score.

I also want to mention the risk of paying too much for your score, the benefits of boosting your score, and a reason why I think FICO is kind of awesome.

Maybe disregard all this?

I made the case that everybody should spend up to $20 to buy their FICO score (and credit report).

But personal finance guru Dave Ramsey makes the following fine point about FICO scores: Ignore them.

That’s fine for his larger lesson, which is to urge people to live entirely debt-free. If you live a cash-only, debt-free financial life, you don’t need a FICO score because you don’t ever need to ask a bank for a loan.

For people at the extreme ends of the financial spectrum, I endorse Ramsey’s hard-core approach to FICO scores and borrowing.

If you can always pay cash because you’ve got unlimited amounts of it, by all means ignore your FICO score. And if you’ve been in distress because of a debt problem that needed curing through bankruptcy or by going cold turkey on borrowing, again I think Ramsey’s right. Ignore your FICO score.

But for the 90 percent of us in the middle, we need to pay attention to our score.

When you know your score before you walk into a bank, you know whether the loan you got offered by the bank is at the lowest rate possible.

If you don’t know your own FICO score, you’re entirely at the mercy of your lender.

Call me crazy, but maybe you don’t want to do that?

What else NOT to do

While I do think we should spend a small amount of money to learn our FICO score, I want to caution people about the FICO-purchasing process.

Do not spend too much money on this. Achieving the right balance of FICO knowledge means not overdoing it. Each of the three credit bureaus, plus the Fair Isaac Corp., will try to encourage you (“trick you” is maybe too strong a word, but that’s basically what they’re doing in my opinion) to sign up for “monthly credit monitoring,” for something like $25 per month or $120 a year.

Don’t do this.

Also, all these folks will offer a “free” credit report and score, as long as you make a long-term (read: expensive) commitment to buy more of their services later.

Again, don’t do this.

Having been through the experience a few times, I will warn you that they make it relatively difficult to simply purchase one credit score from one bureau for under $20, but that simple purchase and price should be your goal.

And it is doable.

Benefits of FICO repair

What’s clear from the FICO formula is this: If you have unpaid bills, taxes, judgments or liens weighing down your credit score, you can turn around your credit score.

Not without settling up with creditors on what you owe, and certainly not quickly, but it can be done. Consider it a marathon, not a sprint. And if you can survive the marathon, you’ll reap considerable rewards.

On your car, with a 720 FICO qualifying you for a prime loan, you might lower your loan’s interest rate by 10 percentage points. On a $20,000 loan over seven years, you’d pay about $100 less per month with a prime loan instead of a subprime loan, or about $8,575 less in interest over the life of your auto loan.

On your home, the differences are much more dramatic still. With a 720 minimum FICO, you might lower your mortgage by 5 percentage points, moving from a subprime to a prime mortgage. On a $200,000 mortgage over 30 years, you’d end up paying $655 less per month, or $236,000 less in total interest over the life of your mortgage.

Even more, a low credit score could lock you out of the chance at homeownership entirely, which might have even more dramatic financial results given the advantages of homeownership.

That’s why small changes in solving past credit problems can lead to big financial results in the long run.

No discrimination

Besides the financial advantage of knowing whether you qualify for a prime loan, I’m a big fan of the FICO score because of its essential “fairness.”

In a way, FICO scores are awesome — because they do not discriminate based on anything about us except our own past borrowing behavior.

I’m not certain the George Bailey “It’s a Wonderful Life” world of banking ever existed — where a banker could personally decide to lend, or not, based on judgments about a customer’s reputation and character. If it did exist, we can imagine that discrimination played an important part of lending decisions.

A FICO score however, does not discriminate based on income, wealth, profession, geography, education level, race, class, gender, sexual orientation, physical ability or the three timeless banker’s questions posed by the Zombies back in 1967: “What’s your name? Who’s your daddy? Is he rich like me?”

When you think about it that way, FICO does something amazing that none of us can do, since we are all (hopefully unwillingly) bundles of human discrimination at all waking moments.

Sylvester_McMonkey_McBean

Yes, a FICO score reduces our glorious individuality into a dehumanized series of digits, to be fed into a banking conglomerate’s Sylvester McMonkey McBean machine and spit out the other side. But, if you understand this dehumanization as the opposite of discrimination in lending practices, you might decide that’s actually a good thing.

 

A version of this post ran in San Antonio Express News

Please see related posts

FICO Part I – What goes into the scoring?

Ask an Ex-Banker: Monthly balances and FICO scoring

 

 

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Ask An Ex-Banker: FICOs Score and Monthly Balances

credit_cardsNote: See Part I on FICO Scores, which inspired this question from a reader.

Dear Banker,

I’ve been getting copies of my 3 credit reports annually since 2005.

I’m concerned about a change in the reported information from Capital One and Chase. My reports used to reflect
1) amount billed
2) scheduled (minimum) payment
3) actual payment

The latest reports from Transunion and Experian no longer reflect the “actual payment” amount, so although my reports show all payments made on time, it doesn’t reflect the full balance being paid monthly as opposed to the minimum payment.

I feel like I have to alternate credit cards in order to have a zero balance every other month so it doesn’t appear that I’m making minimum payments and carrying an unpaid balance.

I’ve contacted Capital One and Chase to ask them to report the actual payment amount as they used to, but all I get is a standard response “we’re correctly reporting your account” to the credit bureaus.

Am I wrong in thinking that if they report amounts in addition to whether or not the account is “paid on time”, they should include actual amount paid as well as amount billed?

Thank you
Bette in SA

credit_report

Dear Bette,

Thanks for reading, and for your good question.

The most important element for FICO scoring (35%) is whether bills are paid ‘on time,’ so if you’re consistently doing that, your score will reflect that, and the fact that there’s a balance on your report is (mostly) irrelevant.

The FICO algorithm doesn’t care whether you make minimum monthly payments or full-balance payments. As long as payments are being made ‘as agreed’ according to the fine print you signed with your credit card company, your FICO score can’t distinguish between people who carry a balance and people who pay off their balance every month. What I mean is your score won’t be hurt by minimum monthly payments, nor can you really boost your score by making maximum/full balance payments. There is (almost) no distinction between them, for scoring purposes.

Small caveat: One small part of your score reflects your ‘usage amount,’ meaning what proportion of your available credit balances are used at the time of the score. Meaning, if you had a total of $10,000 in available credit among all your cards, and you were using $9,750 of that with a credit card balance, that could slightly lower your score. Not much, but a little.
Conversely, If you had a total of $10,000 available credit, but only showed up with a monthly balance of say $300 (leaving you with $9,700 available unused credit), that would slightly raise your score. Not much, but a little.

credit_score_auto_loans
A useful graphic linking credit scores and auto-loan rates

That would be the only sense you could be concerned about the monthly reported balance as you described. However, if you have many thousands in available credit and only hundreds in reported balances, those reported balances are basically irrelevant for your score.

As for you question to Chase and Capital One – I’m sure they won’t change their reporting methods. They just do an automated snapshot on a monthly basis to send to the credit bureaus. On any given day of that snapshot, we (the consumer) may have an outstanding balance on our card, even if we don’t carry any balance month-to-month.

My strong advice – don’t try to alternate card usage, and don’t worry about it, it’s not hurting your credit.

Michael

 

Please see related Posts

FICO Part I – What’s in the Score?

FICO Part II – Ignoring FICO and also why FICO is awesome

 

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FICO Scores – Part I

confessionI’m 43 years old and I have a terrible confession to make: I still know my SAT scores by heart. Wait, it gets worse. I still know my PSAT scores by heart. I know, I know, I’m that guy. I’m not proud of this so let’s move on quickly to another semi-related topic: FICO scores.

Unlike the SAT, everybody should track his or her FICO score throughout adulthood.

I bring up the SAT analogy because you should no more apply for a loan without knowing your FICO score than you would think of applying to college without knowing your SAT score. Like the SAT, FICO serves as a sorting mechanism determining your eligibility, in this case, for lending products.

Any credit card, auto-loan, mortgage, or business loan application you submit will prompt your lender to pull your credit score as a major determinant of your access to their best, or worst, products.

Unlike the SAT, however, you only need to remember one single number to achieve total success: a 720 FICO.

An online universe of FICO-score nerds exists and I’m not writing with that audience in mind, any more than I would encourage SAT nerds to remember their scores 25 years too many. (Yes, I’m looking right at you, mirror.)

FICO determines loan quality
If you’ve got a 720 FICO, considered by most banks the cutoff for “Prime” loans – the ones with the lowest interest rate and best terms – then you can stop nerding out about your FICO score. A higher score than 720 gives you nothing but bragging rights.

If you’ve got lower than a 720 FICO, expect to pay more in fees and interest, with fewer options. Borrowers in the high 600s may still qualify for what’s known in the banking world as “Alt-A” loans. Borrowers with a FICO score in the mid 600s or below either qualify for Subprime loans – a high interest rate, high fees, and somewhat punitive terms – or no loan at all.

What to do

So how do you access your score? The FICO company, as well as the three credit bureaus Equifax, Experian, and TransUnion each offer personal credit reports and scores for less than $20 each. You can spend a couple of minutes online to access your report and score, and I highly recommend doing this before applying for a loan anywhere.
You really don’t need to buy more than one score with one report from one bureau, so you should be able to accomplish your goal for under $20.

Free credit report?
Consumer advocates trumpet the idea that you can get a free credit report each year, which is true.
But that report does not come with a FICO score. I don’t think that a credit report without a credit score fully equips you with all the knowledge that you need.

To return to my college analogy, a free credit report with no FICO score is like a college application full of essays but no SAT score. You are not getting the full benefit of seeing your application the way a bank sees it, which is ultimately one of the main points of reviewing your credit profile. I advocate spending the money to get the score along with your credit report.

Inputs to FICO
So what does FICO measure? The Fair Isaac Corporation, the company behind FICO, reports that five factors go into their mathematical formula, all of them measurements of past borrower behavior.

I’ll list the factors in order of importance, according to their formula.

fico_scoringFirst: – Have you ever missed debt payments, and if so, how often and how recently? (35 percent)
Second – How much do you owe now? High debt lowers your score, while low debt compared to your available credit actually raises you score. (30 percent)
Third – How long have you been borrowing money? A longer time raises your score, while a shorter time lowers your score. (15 percent)
Fourth – FICO considers some types of credit like installment loans riskier than other types of credit like mortgage loans, and adjusts your score as a result. (10 percent)
Fifth – Have you applied recently for credit? This lowers your score a bit, as it shows you need to borrow money. (10 percent)

Lesson One: Time
Reviewing these five factors, we can see that the biggest determinant of your score is time: Specifically, are you timely with your bills, and how long have you responsibly handled debt?
Because of the impact of time, even younger borrowers with perfect credit history cannot achieve very high FICO scores (in the 800s), whereas older borrowers have a natural advantage because they may have very ‘old’ credit lines boosting their scores.

Lesson Two: No tricks
You should never make a financial or borrowing decision based on how it will affect your FICO score. Instead, just do the ‘right thing’ in your situation, and the FICO will work itself out. Paying your bills on time, lowering your balances when you can, building up a long-term track record of ‘safe’ borrowing behavior is the only reliable method for boosting your FICO.

Plenty of ‘services’ claim to be able to boost your credit score, but I would never recommend attempting any of these. Like many other areas of finance, the best practice is to ignore short cuts and tricks. Just stay focused on the long-term unsexy practice of paying back your debts. The FICO score will work itself out in the long run.

a_lanniseter_always_pays_his_debtsWhen I say you should avoid tricks and mostly ignore your FICO score, I don’t mean to ignore the underlying issue of settling past debts. The best practice is to make like a Lannister, and always pay your debts.

Next week I’ll write about when to totally ignore your FICO score, but also the financial advantages of not ignoring your FICO.

A version of this post ran in the San Antonio Express News.

 

Please see related posts:

Ask an ex-banker: FICO scores and monthly balances

FICO Part 2 – When to ignore FICO, and why FICO is awesome

 

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More on Subprime Lending Policies from the Feds

Editor’s Note: A (shorter and less conversational) version of this post appeared earlier today in the San Antonio Express News.

hud sealAn official from the Department of Housing and Urban Development (HUD) responded last week to disagree with my article two weeks ago in which I claimed that Secretary Julian Castro supported subprime lending, in his speech about HUD priorities September 16th.

We had a lovely chat.

What Castro said

What Castro actually said in his speech is the following:

“According to the Urban Institute, the average credit score for loans sold to GSEs [*which stands for ‘government sponsored entities,’ shorthand for Fannie Mae, Freddie Mac, and Federal home loan banks] this year is roughly 750. Currently, there are 13 million people with credit scores ranging from 580 to 680. Many of them are ready to own, but are being left out in the cold. The truth is that the dream of homeownership is out of reach for too many Americans. This has to change.”

I interpreted ‘this has to change’ to mean he advocated greater subprime lending. Castro specifically included credit scores that meet the ‘subprime’ definition, even though he did not use the phrase ‘subprime lending,’ probably because after the 2008 crisis ‘subprime‘ became a dirty word.

Definition of subprime

Banks sort mortgage borrowers according to their FICO scores, a personal-credit score based on past borrower behavior.

A 720 score and above is considered “Prime.” A 680 FICO and below is considered “Subprime.” To fill out the middle part of the scale, a 680 to 720 score is generally considered “Alt-A,” an in-between designation of credit worthiness.

Reasonable people can quibble on the exact FICO boundaries between Prime, Alt-A, and Sub-Prime, and banks can make their own determinations of the ranges for their own lending purposes, but 680 and 720 are the traditional boundaries separating the three segments of the mortgage market.

To make the definition completely clear: If you have a 680 FICO or below, to name one FICO score Castro mentioned in his speech, you have a history of not paying some of your debts on time. If you have a FICO score closer to 580, to name the other score Castro mentioned, you have a history of not paying most of your debts on time.

There’s no other way to have a 580 to 680 FICO than to have missed debt payments.

This doesn’t mean you’re a bad person. Nor does it mean you should never own a home. It just means that your past payment behavior suggests elevated future risks of not being able pay for your debts, such as a mortgage.

Most importantly, with a FICO of 680 or below, you will only qualify for a subprime mortgage from your bank.

So that’s why I think I made the reasonable inference from Castro’s speech that “This has to change” indicated a government preference for more subprime lending.

“Fair Access”

The HUD official did not agree with my description.

When I pointed out to the HUD official that historically 20% of subprime borrowers get into payment trouble on their mortgages, the official said I should focus instead on the 80% of borrowers who do not get into trouble, the ones who pay their mortgages on time.

HousingRow

Shouldn’t those 80%, he argued with me, have ‘fair access’ to the dream of homeownership?

Yes, of course. Nobody could ever disagree that people should have ‘fair access.’

He argued with me that the point of HUD policy is to ‘remove the barriers’ to the 80% of borrowers with bad credit who will pay their mortgages on time.

Removing barriers also seems great to me.

The much more difficult task is to figure out what ‘fair’ means, and what ‘access’ means. And what are the lending barriers that HUD wants to remove when it comes to borrowers with FICO scores below 680?

I would argue, and I did to Castro’s colleague at HUD, that the focus on positive outcomes for the 80 percent of subprime borrowers who pay their mortgage on time kind of finesses the point, by shifting the conversation away from the other 20 percent who will not be able to pay their mortgage.

And, in my opinion, the point is whether federal government policy should put its thumb on the scale to increase access to a market in which 20 percent of borrowers could lose their home due to non-payment on their mortgage.

In the end, however, I should not have worried too much because I don’t think the policies advocated by Castro will do much.

Actual Policy

House in Hand

It turns out, according to both the official and the follow-up materials his office sent me, that what Castro and HUD mean by “this has to change” is something pretty mild.

They mean a three-part program of
1. Encouraging borrower counseling
2. Clarifying lending standards (with an updated FHA Handbook!)
3. Analyzing additional data on mortgage lenders and sample mortgages

That all seems reasonable. In addition, this isn’t going to open the floodgates to increased subprime lending anytime soon.

Which leads to an interesting – albeit convoluted – ‘lets-agree-to-disagree’ point between myself and the HUD official.

Whereas I don’t think HUD should encourage more subprime borrowing and he does, I don’t think the federal government’s policies will have much effect, and he does.

So we’re both happy. I guess?

We all do this

Let me shift away from using the words “Castro” and “HUD” and “Federal Government” now to make this less personal, and frankly so it doesn’t seem like I’m politically attacking San Antonio’s golden child.

I’m going to make the decision-maker in the following sentences simply “We.”

Because I think we all do this.

As a society we are in the habit of wanting two contradictory things at the same time when it comes to banking policy, even though they are somewhat incompatible with each other.

For equality-of-access reasons we want banks to lend to more people, especially the neediest people, despite the fact that such lending is historically quite risky for both the bank and the borrower. The borrower, who we want to help, can wind up without a home, in bankruptcy, and with further wrecked credit. Banks can lose money, which – when this happens systemically – can crater an economy, as happened in 2008. In these indirect ways, therefore, increased subprime lending is quite risky for society.

subprime mortgagesAt the same time – or shortly thereafter, when 20% of these mortgage loans go bad, as expected – we want to punish banks for lending to the neediest people, “when the banks should have known better,” or when a loan to a needy person ends up looking predatory because either the rate is very high, or the collateral (the home) was seized in foreclosure, or both.

So we can all want these contradictory things at the same time, but I think we can also acknowledge that it’s all kind of hypocritical, no?

 

Please see related posts:

HUD Policy – The Good And Bad So Far

Mortgages Part VIII – The Cause of the 2008 Crisis

Mortgages Part V – Good Debt or Dangerous Drug?

Book Review of Edward Conard’s Unintended Consequences

Audio Interview Podcast – Mortgage Originator Explains the Crisis

 

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