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Credit crunch shifts consumer lending landscape

An old joke used to be that in tough times, banks lend money only to people who don't need it.

But it's not a joke.

The credit crunch is starting to affect consumers directly, as banks upgrade their standards for credit cards and loans. So even if overall interest rates hold steady — and for the most part, that seems to be the case — the financial meltdown on Wall Street is making it increasingly difficult for the average consumer to get the best rates on credit cards and bank loans.

It's not a problem if you earn lots of money and have a high credit score — in short, if you don't really need credit. But it's getting more costly for the rest of us, and that could be a problem as the holiday shopping season approaches.

"I think banks have raised the bar on what they consider excellent credit," said Ben Woolsey, director of marketing and consumer research at CreditCards.com.

Rates that issuers promote are still about the same, said Bill Hardekopf, CEO of LowCards.com.

"But if you and I both apply for a card, you could have excellent credit and get 7.99 percent, I could have good credit and get 9.99 percent, and someone else might get approved at 11.99 percent," he said. "It will depend on your credit score."

The FICO number — for Fair Isaac Corp., the company that developed the rating system — determines whether you qualify for credit, as well as the interest rate and other terms.

"FICO scores help lenders make accurate, reliable and fast credit-risk decisions across the customer life cycle," Fair Isaac says on its Web site. "The scores rank-order consumers by how likely they are to pay their credit obligations as agreed."

The logic behind FICO scores generally makes sense, but any time you replace human logic with unfiltered numbers, you can get illogical results.

That's what's happening now.

In an attempt to reduce their exposure, card issuers are cutting credit lines, and not always due to overt actions by the consumer.

Credit card issuers are free to change your credit limit or other terms any time they want, "so you may not be aware that the rug has been pulled back a little," Woolsey said.

Besides raising your chance of going over your limit and being hit with hefty fees and having your interest rate increased, the ratio of credit card utilization could become higher, which can make life even more difficult.

For example, if you have a credit limit of $5,000 and charged $2,500, you would be using 50 percent of your available credit. But if your max is cut to $3,000, that same outstanding balance would amount to 83 percent of your credit limit.

"That makes you look riskier, and your credit scores could go down, even if you haven't changed your habits," Woolsey said. "It's not a good outcome for consumers."

How you're scored

FICO scores range from 300 to 850, with 60 percent of scores between 650 and 799. According to Fair Isaac, the median score is 723, whereas according to credit-rating agency Experian, using the Fair Isaac risk model, the average credit score is 678. A FICO credit score is made up of these five factors of varying importance:

Debt-to-credit ratio
(30 percent): Outstanding balance vs. available credit. Experts say it's best to use less than 30 percent of your available credit. The lower the percentage the better.

Payment history
(35 percent): Scores take into account how late you were, how much was owed and how many late payments there were.

Length of credit history
(15 percent): If you're closing credit card accounts, keep the ones you've had the longest. If you want to make sure your credit cards are counting toward your debt-to-credit ratio, you should use them at least once every six months or so.

New credit (10 percent):
Signing up for several credit cards in a short time can lower your score, because you may appear to be a bigger risk.

Types of credit (10 percent): Considers the mix of different types of credit, such as installment loans or mortgages. It's good to have a history of revolving accounts, such as credit cards.

Credit crunch shifts consumer lending landscape 11/08/08 [Last modified: Friday, October 28, 2011 11:00am]
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