The Cost of Borrowing is Going UP!
Posted by John Draper | Filed under Credit Wise
Getting a loan costs money. You know that. But do you know that the worse your credit history the more the loan will cost. Routinely I work with people who are carrying car loans, even consolidation loans, at wickedly high interest rates. All because they’ve ruined their credit and the lender is making them pay for the higher risk of default that they pose.
With the recent credit crunch, some borrowers can’t get a loan at all because they don’t meet the new higher minimum credit standards. Yup. The criteria are changing, and it’s getting tougher and tougher to satisfy lenders.
According to a New York Times article on October 28th, “Lenders wrote off an estimated $21 billion in bad credit card loans in the first half of 2008 as more borrowers defaulted on their payments.” As a result “Faced with sobering conditions, companies that issue [credit] cards are rushing to stanch the bleeding”.
Credit criteria have always existed but have been virtually ignored in the past few years as credit been flung at us from all sides. In a rush to grab market share, lenders have forgone the rigorous credit analysis they used to do, relying more heavily on “credit score” for their decision-making. Now, with the credit marketing having dried up, those credit standards are likely to come back into play.
The credit standards are referred to as the 5 C’s of Credit: character, capacity, credit history, capital and collateral.
Character shows on your credit history in terms of your willingness to accept responsibility for making your payments on time. Skip a couple of payments, or make ‘em late, and you’re showing yourself to be of low character. Taking on too much credit also reflects on your character, as does moving around too much, changing jobs frequently, and why you’re choosing to borrow.
Capacity is your ability to repay the loan. Your income, how long you’re choosing to take to repay the loan, and your familial responsibilities all play into your capacity. Debt service ratio is the calculation most often used to test your capacity.
Credit History: You know the old saying, “History has a way of repeating itself”? Well, lenders know this to be true. Your credit history provides a snapshot of how you’ve handled debt in the past, and is a big influence on a lender’s willingness to “take a chance on you.”
Capital refers to what your balance sheet looks like. If you haven’t built up any equity – be it in a home, in a retirement plan or in a savings account – then you’re not likely to score high on the Capital scale. And if you’ve taken on loads of debt, that hugely offsets your assets, reducing your Capital Score.
Collateral is what you may offer to offset the risk of you defaulting on the loan. If you have a home and take a mortgage, the property itself is the collateral, which is why mortgage rates are usually much lower than all other forms of borrowing. Car loans should also be less expensive for much the same reason. However, I’ve seen people paying upwards of 28% interest on car loans, which means that everything else on their 5 Cs must really suck.
It’s more important than ever to understand, monitor, and manage your money if you’re in the market to borrow. And don’t think that just because you have a pristine credit record that it’ll continue to be cheap money. Nope. You can count on the cost of borrowing to go up. According to the New York Times, “Even those with good credit ratings are not excepted. American Express, which traditionally catered to more upscale cardholders, said it would be increasing effective interest rates by 2 or 3 percentage points for some of its credit card holders.”
November 6, 2008 at 11:30 am
Wow. In my opinion, this makes it a perfect time for all of us to learn how to plan and save carefully for purchases and learn how to make credit work for us, instead of against us. In the long-run, it might be a good thing, encouraging people to think differently about credit, be more responsible, and have fewer opportunities to rack up consumer debt.
November 6, 2008 at 12:13 pm
My thoughts exactly Saver Queen.
(I’m so glad all our credit cards are paid off…. )
November 6, 2008 at 12:35 pm
Credit effects many things. We have a basement apartment for rent. A nice young couple filled out the rental application and we have declined them because they have a # 9 rating for not paying a CIBC bill.
November 6, 2008 at 2:54 pm
i say great. now sadly, the credit card companies single handedly caused this problem and made a killing in the mean time. but now that there is nothing left to pillage from the people, they are taking some responsibility and doing things the way they aught to be done.
maybe this will set a precedent for future lenders and borrowers, in the chapter of ‘what not to do to crash an economy’.
their greed has come back to bite them in the @ss and the good old days are over.
but this could truly have never happened if there wasn’t a demand from the people. no demand, no supply.
November 6, 2008 at 7:15 pm
Kristin, you touch briefly on this, but to be clear — the people who used the credit cards irresponsibly caused this problem, not the credit card companies themselves. Some posters on this site think banks, credit card companies, financial institutions, investment companies, etc are all evil people taking advantage of children. The simple fact is that while these companies may have helped some people dig a big hole for themselves, ultimately it’s the grown-ups who signed on the bottom line and now plead ignorance. No one with credit card debt had a gun held to their head when they went shopping. Some choose wisely and some choose…. poorly. People should be accountable for their actions.
November 6, 2008 at 7:55 pm
Geoff – While you are right, the cc companies were enablers. They may not have been the ones who caused the problem but their actions, or lack-there-of, did enable the situation, so they aren’t blameless.
I guess the big thing is: here we are. It’s where everyone goes from here and what they learn that matters.
November 6, 2008 at 8:11 pm
geoff- you won’t hear an argument, everyone needs to be 100% responsible for themselves. but when large rich corporations take advantage of the weak and vulnerable for profit, i feel some blame needs to be passed around.
if you lead a horse to water, it chooses to drink but who can blame it. it doesn’t know better, its a horse.
i think that our society has been totally taken advantage of. 0ur human side has been over exposed and our natures taken advantage of.
i also blame our education system and our government for introducing all these things and taking the time in educating no one on exactly what all these things are- good side and bad!
you have 100% personal responsibility, but as for responsibility to your community, your people and ethically, it’s not the consumer alone.
November 6, 2008 at 8:34 pm
I am slightly relieved it will be more expensive!
I think they have simply made it too easy to get in too deep, and I am a happy that it will be tougher and more expensive to borrow. I know the Big Bad Credit Companies have made a fortune off the average Joe, but like Geoff, I think adults need to take responsibility for how much sh*# they can shovel and not count on others to make those calls for us.
It’s the people that rack it up and then complain about the interest they pay… those people make me sad… you spent money you didn’t have! In fact you spent the LENDERS MONEY! Did you think it was going to be GIVEN to you? GEEESH.
November 6, 2008 at 10:11 pm
People love to point the finger at one person, or group of people, and say “it’s all your fault.” Not just when discussing this particular issue, but in regards to all kinds of highly complex sociological problems. Pointing singular blame is easy but it just doesn’t do a social or economic problem justice. I agree that everybody has to take responsibility for their own lives, and until you begin to recognize that it is you and you alone who can change your life for the better and get you out of debt, you will continue to struggle. That being said, people are not simple creatures. We have weaknesses, vulnerabilities, needs – sometimes hidden needs – and insecurities. We do not always behave logically. And we are highly impressionable creatures, desperate to be loved and accepted by our own – and unfortunately in our society, impressions of wealth are considered important, even a necessary part of “success.” Corporations and other entities may prey on all of these vulnerabilities, telling us, you are not loved until you have a diamond. You are not a man unless you drive an expensive car. This new gadget will fill the hole in your heart. A woman is worthless unless she looks like Angelina Jolie. And I am sure that when people first begin to fall into the debt trap, they do not realize what a fast trip it is towards the downward spiral. While I do not have debt myself, I do believe that you cannot divorce peoples’ choices from the broader context in which they live.
November 6, 2008 at 10:35 pm
I’m so glad we all know about Gail’s advice & site. Great comments from SaverQueen, Geoff, & Kristin.
We use the jar system and recently what we’ve been doing is any change (not loonies or toonies) in the jars we set aside in different jars & then paper roll the change. Once we’ve accumulated enough rolls to make the trip to the bank worthwhile, we deposit it. Then as soon as we’re home we online transfer the exact amount to debt repayment.
It all adds up! Now is certainly the time to get rid of ANY debt! as much as you can.
November 7, 2008 at 2:30 am
A couple of days ago, Bloomberg reported:
“Credit card companies were shut out of the US market for bonds backed by customer payments in October for the first time in more than 15 years, as investors shunned the debt amid the global credit freeze.
A weakening job market and a looming recession are making it harder for consumers to make monthly payments, eroding confidence among investors about the safety of credit-card-backed bonds.”
Credit card debt is going to get very expensive, which is why I’m pleased I followed one piece of Gail’s advice – I got a personal loan from the bank (single-digit APR) which covered nearly all of the cc debt (25% APR). This week I paid off the remainder on my cc which now has ZERO balance. I still have to complete the personal loan but I’m not being crippled by the cc interest rates which, I have no doubt, would be skyrocketing.
If there is anything anyone can do to reduce – or ideally eliminate – cc debt I suggest they do it because they will only get squeezed harder and harder.