There is a magic number in consumer credit reporting: 800. It represents a really good consumer credit report. That number — or rather, your proximity to it — affects whether you can buy appliances, a car, or a home.
Most people know they have a number representing their credit rating, but not necessarily how that number is derived. Sure, it’s based on whether you pay your bills on time, and whether you’ve ever declared bankruptcy, but there are other factors that enter into it. How many credit cards do you have? How high are the balances? How much do you pay off each month?
Another important one: what’s your utilization ratio? Utilization represents the amount of credit you have versus the amount of credit you use. If you have a $50,000 credit line and you generally charge about $10,000 per month, that’s a 20% utilization rate, which is okay. If you’re constantly bumping your head against your credit ceiling, that’s a problem.
Most of this is well-known to the segment of the population that regularly buys houses, cars, and applies for credit cards; call that Segment A. There is another segment of the population to whom this is completely unknown. The people in Segment C are not necessarily poor or unemployed or on welfare; they simply live their lives without benefit of credit cards, and frequently without benefit of checking accounts. They are paid in cash and only spend cash. Though they are frequently highly contributing members of society, they are financially “off the grid.”
In the middle is Segment B. In this group are people for whom credit has been difficult, but not impossible, to get for most of their lives. Some of them may be the people who saw housing becoming more accessible in the mid-2000s and got a loan with no down payment that assumed housing values would just go in one direction — up. Some of them may be people who were seeing friends and colleagues enjoying the good life and plundered their home equity lines for the wherewithal to keep up with them.
But also in this group are people who played by the rules all their lives and are now facing catastrophic events. I have a client who has always paid his bills on time, but his spouse lost her job. The financial strain has pushed them toward divorce. They’re facing the prospect of selling a house without any equity. Whether the house is sold at its current price (if they indeed can sell it) or it goes into foreclosure, his credit will be negatively affected; he’ll be forced to live off credit cards, but he doesn’t have an abundance of credit.
My sense, based on stories like this, is that a whole cluster of those in Segment B are about to be joining Segment C, perhaps permanently. And with credit getting more difficult to get — car dealers are having trouble financing loans — what does that mean for this group? Credit reports are a measure of trustworthiness, so if someone does not generate data to appear on a credit report, does that mean they are not trustworthy?
Certainly not. One of the people DBNR sold a house to is a very successful craftsman who simply had a cash business. He didn’t have a credit rating, but he had tax returns that told us what he made.
But as the numbers in Segment B begin to shrink and those in Segment C swell, the trend could have massive impact on our economy — both good and bad. Next week: the economic and societal ramifications.
