Help for 43 Million Americans With Bad Credit

NEW YORK ( TheStreet) -- A little more than a quarter of Americans have poor credit, according to a recent FICO ( FICO) study. A total of 43.4 million people now have a credit score of 599 or less.

Expect that number to grow as households struggle through unemployment, credit card debt and foreclosures.

HOW DID WE GET HERE? People don't get into financial problems overnight. It took years of overspending, overlending and poor regulation to create these problems. Lenders, and even the government, share some of the blame.

The government helped open the door for higher rates and fees in 1978. At that time, a majority of states had usury laws that capped interest rates on credit cards, usually at about 18%. That year, a U.S. Supreme Court ruling in Marquette National Bank vs. First of Omaha Service Corp. held that national banks could charge credit card customers the highest interest rate allowed in the bank's home state, instead of the customer's home state. Many major banks moved to states such as South Dakota and Delaware, where there were no usury limits on interest rates.

In the early 1990s, credit card issuers advanced beyond one-rate-fits-all offers and used credit scores and financial data to develop pricing and credit strategies. They set rates and limits based on computer assessments of an individual's risk of default -- the higher the risk, the higher the interest rate. This new data led to such innovations as increased credit limits and decreased minimum payments.

These new, advanced risk assessments created opportunities to lend to people who were a higher risk, including people who should not have had credit. The new loans and higher credit limits were profitable for banks, but made the problem worse for borrowers.

In 1996, another Supreme Court ruling called Smiley vs. Citibank ruled that fees should be included with the balance and could be determined by what the bank's home state would allow. This ruling allowed issuers to charge more for fees and create others, such as over-the-limit fees. This ruling also opened the door for such punitive practices as the Universal Default clause.

The days of loose lending for mortgages and credit cards, high rates and fees, second mortgages and borrowing beyond more than you could repay couldn't last forever. The crash came in 2008, with tremendous losses for borrowers and lenders.

Banks and credit card issuers responded by slamming the brakes on lending. They cut credit lines and increased interest rates. Reduced credit limits hurt borrowers' credit scores, and higher interest rates made it harder for them to pay down their balance.

Credit card issuers reacted strongly and quickly to protect themselves, but a result is that 25% of Americans are practically banned from inexpensive credit and many financial options just when they're needed most.

CAUSE AND EFFECT: Here are three actions that lower credit scores.

Debt-to-payment ratio increases. This happens when you add to your outstanding balance, moving you closer to the credit limit; or when the issuer reduces your credit limit. A higher debt-to-credit ratio is seen as a risk and can result in a drop of about 20 points.

Late payment. Some experts believe a few late payments on a credit card or other loans can lower a score by as much as 100 points if the consumer has a great score or 80 points if the score is average. Making payments on time is a big step toward improving a credit score.

Defaulting on a loan or foreclosure may lower a score by as much as 200 points.

Here's the basic breakdown of how long different types of negative information stay on a credit report:

Late payments: seven years.

Bankruptcies: seven years for Chapter 13, in which the debtor keeps control and ownership of assets and works out a three- to five-year repayment plan; or 10 years for Chapter 7, in which a trustee liquidates assets to pay back debts.

Foreclosures: seven years.

Collections: About seven years, depending on the age of the debt being collected.

Public record: Generally seven years, although unpaid tax liens can remain indefinitely.

The older the negative item, the less impact it will have on your FICO score, though. A collection that is five years old will hurt much less than one that is five months old.

THE PAIN: A subprime credit score is just a number. It doesn't tell the individual story or reasons a person gets into financial trouble. It doesn't tell of the stress caused by higher loan rates or increased insurance premiums because a credit score paints a picture of high risk. But lenders, insurers and even employers will make judgments and decisions based on that number.

Car loans, mortgages, credit card loans -- all cost more when you have a subprime credit score. This puts additional strain on a budget that is already breaking.

When consumers have made poor financial choices and damaged their credit score, they are on their own to fix it. There is no federal bailout or TARP fund that will rescue them.

TO RAISE YOUR CREDIT SCORE: It's important to note that raising your FICO credit score is a bit like losing weight: It takes time, and there is no quick fix. Here are a few tips for raising your credit score.

Get a copy of your credit report from all three credit agencies. U.S. residents are entitled to one free copy of their credit report from each credit-reporting agency once every 12 months. This information is found by calling 1-877-322-8228 or going to AnnualCreditReport.com. If information on a report is incorrect, contact the agency to correct it. Wrong information should be corrected or removed within 10 to 30 days, and doing so may give your score a quick boost. Your credit score is usually not shown on the free annual credit report. There are paid options that will allow you to see it.

Pay bills on time. This is the single most important factor in your credit score. Even if you only pay the minimum, do it on time. Late and missed payments can quickly lower a credit score.

Pay off your debt. High balances and high debt ratios drag down credit scores. A debt balance should be less than 35% of a consumer's available credit. If you have a good payment history, contact your creditors and ask for lower interest rates. Then use what you saved in interest to pay down your balances.

Build a long-term relationship with the accounts you have. A long history of good payments on a car loan, mortgage or credit card increases your credit score. Keep older credit card accounts open, even if you are not using them, because you are rewarded for a long, positive credit history. If you review your credit report and discover accounts you no longer use, close the newest ones first.

Limit your credit applications. Too many new accounts can lower a credit score. Each time you apply for a loan, the application shows up on your credit report. A significant increase in inquiries signals you are desperate for money and are a credit risk. The exception is shopping for a mortgage or a car loan, as multiple inquiries for the same purpose in a reasonable period are considered a single inquiry.

Get a checking and a savings account.

Do not co-sign for a loan for someone else. This shows up on your credit report, and a missed payment or a maxed-out credit card by the other person will affect your credit score.

If you can't pay your bills, contact your creditor or see a legitimate credit counselor. The National Foundation for Credit Counselors, a not-for-profit organization, can give counseling and help you put together a debt-management plan.

NEW LEGAL PROTECTIONS: Under the financial reform bill passed two weeks ago, there is a law dictating that a lender is legally responsible for assessing a borrower's ability to pay. Lenders will have to verify borrower income to make a loan.

Additional consumer protections and regulations include: free credit scores for those denied credit or offered only higher rates because of negatives on their credit report; a ban on broker incentives to steer homebuyers into pricier loans; and penalties for institutions that lend irresponsibly.

-- Reported by Bill Hardekopf of LowCards.com.
Bill Hardekopf is chief executive of LowCards.com, which compares and rates more than 1,000 credit cards. He is the co-author of "The Credit Card Guidebook."

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