Thursday, August 30, 2012

The Costs of Bad Credit Part 2

The cost of bad credit can be very high; provided a credit issuer will give you credit. Last week, we looked at the costs of incurring bad credit such as late fees and higher rates. This week we will take a look at who may lend to a risky borrower and the extended cost of bad credit.

A credit score indicates to the lender the likelihood of a loan being repaid. The higher the FICO score, the more likely a loan will be repaid. Often times, those with low scores are offered a higher (AKA sub-prime) rate for car, home, and other credit purchases. It would not be unusual for someone with a low rating to be offered a 10-14% or higher interest rate on a used car loan when the prevailing rates for someone with a good credit rating would be about 7% or less. That was prior to the recent recession. Lenders are much more conscious of the defaults in subprime loans that have occurred over the past 5 years. Many have stepped away from the subprime market completely. Thus, for many lenders, either you qualify for a loan or you don’t. The subprime loan is no longer an option for many traditional lenders or many borrowers.

There are still some institutions that will lend to people with slightly less than perfect credit; they are known as credit unions. Why? Because credit unions take a more holistic approach to lending to their members. The FICO Score is important, but is not the only factor considered when lending. A credit union may require a higher down payment of subprime borrowers and/or ask them to pay a slightly higher interest rate. They will look at the applicant’s employment; how long have they worked for the same company? How long have they lived in the same home or neighborhood? How has the member managed their credit over the past 24 months? The answers to these questions may increase or decrease the interest rate or down payment.

As an example, let’s say a FICO score of equal to or greater than 740 is the target score for the institution and someone in that score range will get a rate of 2.99% for a new car loan with zero down. In this case, if someone misses the target by a bit, say the member comes in at 680, the credit union would likely make the loan with a somewhat higher rate than the base rate to help the member. Instead of 2.99%, perhaps the loan would be for 5.50%.

In this case, a car loan of $15,000 applied for a borrower with a 740 score and a borrower with a 680 score, there is a 2.51% difference in the loan rate (2.99% APR vs. 5.50% APR). The borrower with the 740 score will pay only $934 in interest over a 4 year period where the borrower with the lower score might pay as much as $1,745; a difference of $811 over the four year loan term. The borrower may not only be required to pay a higher interest rate, they may have to come up with money for an additional down payment. Subprime borrowers are often called upon to have a higher equity in their security than those with preferred rates. That is an additional cost to the subprime borrower. That is money that has to come out of savings leaving the borrower with reduced liquidity. Another cost is the loss of earned interest on the money used for the down payment. Let’s say the borrower has to put up an additional $3,000 in order to qualify for the loan, $3,000 in a savings account at 1% APY for 4 years would have earned $125. That’s better than spending an additional $800 in interest expenses.

Avoid these increased costs by managing your credit correctly.
  • Pay your bills on time and pay more than the minimum when possible.
  • Pay down outstanding balances.
  • Avoid using your entire credit available limit
  • Only apply for credit when you want it. Don’t apply for a card just to get a discount!
  • Read your credit contracts. Don’t get caught in a consumer trap. 
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Are you planning on buying a home? This is one of the great times to purchase one. Loan rates are low and home prices are starting to rise!  If you are ready to buy, visit our next Homebuyer's Seminar here at the Meriwest Credit Union main office on Sept. 8th. Get all the details you need to finance your home purchase! 

Curious about rates? Here are some links to our current interest rates on consumer and home loans:

Auto Loans - New and Used

Home Loans

Equity Lines of Credit

Friday, August 24, 2012

The Costs of Bad Credit – Part One

I have always thought having and using credit was expensive. The whole idea of paying money to use money irks me. In our society, borrowing money is a necessary evil in order to build a good financial history. So, after high school or college, we enter the financial world and start using credit. Some of us used credit to enhance our lifestyles with purchases of stereos and TV’s; others purchased cars or even homes. Of course, we were all aware there is a cost to using credit. We pay a fee known as interest to borrow or, in a sense, rent the money we don’t have.

But for some of us, there were some hard lessons learned about the costs of using credit. When a payment is late, there is an additional late fee added on to your costs. A typical credit card late fee can be as high as $35. The late fee on a mortgage can average 5% of your monthly payment. A $3,000 monthly mortgage payment would have a late fee of $150! Late loan payment fees apply to RV loans, motorcycle loans, ATV loans, and other types of consumer loans.

Credit card companies will not only charge you a late fee, they will also charge the cardholder penalty interest. Your credit card’s interest rate may be a nominal 14.5%. But a late fee will cause that rate to more than double to 29.99%! Now any money you borrow through your card will cost you twice as much in interest as it did prior to your late payment. What’s the difference? One thousand dollars held for one year at 14.5% interest will cost a borrower $145. The same amount of money held for one year at the penalty interest rate of 29.99% results in a cost of $299! Is it like that forever? No. If you make six months of on time card payments after being charged with a late payment, you can get your credit card’s interest rate back to the original rate.  

Another one of the costs of credit are the fees paid by someone who allows a debt to go into collection. A debt or bill becomes a collection when the debt is reaching its first date of delinquency; usually the 90th day of nonpayment. At that point, the firm holding the debt can try to collect it themselves through their lending department or internal collection department or they may sell the debt to a collection agency. That collection agency buys it at a discount of 10%, 20%, or more from the original holder. The agency will also place their own “collection” fees on the debt. This may increase the debt by another 10% or so. When you consider late payment fees and collection fees, it makes paying on time look so attractive!

Late fees, penalty interest rates, and collection fees are only part of the cost of bad credit. Making credit mistakes also means there is a hit on your FICO score, reducing it. When one’s credit score gets low, the cost to do business via credit increases.

Part 2 of "The Costs of Bad Credit” will feature the expense of high cost credit products intended for families with compromised credit scores who cannot access regular affordable credit products. Check this blog next week for the scary conclusion to, “The Costs of Bad Credit.”

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And don't forget our Meriwest Facebook page.  We love to get new fans and have them check in when they visit our branches. It is also a great way to keep up with new products and services and what your credit union is doing in the community.

Our next "Credit Myths and Repair Workshop" will take place at our Milpitas Financial Center on Aug. 29th at 6PM. Credit Myths goes over the Top Ten Myths of credit and how to access your credit report for FREE.  I hope you can join us!

Have a great week!

Thursday, August 16, 2012

Qualifying for a Home Loan - Jumping through the Hoops

As a recovering banker and branch manager who has processed hundreds of home and consumer loans over 30 years, I would like to provide my readers some insights into loan qualifying for a standard conforming home loan of $417,000 or less. If you have not checked lately, the approval bar for loan qualifying has been raised over the past few years. The first adjustment to the bar was on credit qualifying. The credit score required for a typical home loan five years ago was 680. That was the score everyone was shooting for. Today, that can be 720, 740, or even higher depending on the underwriting standards to which the borrower is being held. Each financial institution sets its own criteria based upon their risk tolerance.
The next criteria we will look at is the borrower’s income. Do they have enough to make their loan payments and other obligations? Lenders use a debt to income ratio to determine someone’s ability to make their monthly payments. The ratio usually varies between 30% and 40% of monthly income; meaning that the borrower’s loan payments and other credit obligations should be no more than 30%-40% of their total gross monthly income. If someone is at or below this ratio, they are in good shape for an approval. If they are over, they may need to consider a smaller house, paying off other debt, or adding a second job to improve their debt to income ratio.
We have looked into credit and income. There is a third rail in this mortgage process and that is the value of the home. Today, for the best interest rates, lenders are looking for borrowers to put down 20% of the appraised value or sales price of the home. What this gives the borrower is equity. In this case, equity is the amount of the value of the home that is not encumbered by a loan. So, if we are buying a $200,000 home, we would need to put down $40,000 as a down payment. This would mean you would be financing $160,000 and your payments would be based on that amount. Making a down payment can help with your debt to income ratio as well.
Why do lenders require so much equity? There are many reasons. There may be a downturn in the market and the lenders want to protect their loan and prevent the home from being “under-water” should a real estate market downturn take place again. If the lender needs to foreclose on the property, there is a cushion of equity to cover costs of the foreclosure process. But the main reason lenders require equity is that now the borrower has some skin in the game! In the case of the $200,000 home, the borrower has $40K invested in the home. Anyone with that sort of personal investment is not likely to walk away from the home should they have some hard financial times.
Qualifying for a conforming mortgage loan is no different today than it was ten years ago before the residential real estate bubble started. A borrower has to meet credit standards, income requirements, and the home must qualify under the loan to value ratio which is generally 80%, requiring a 20% downpayment for a standard conforming home loan of $417,000 or less.
Final Word to the Wise: This Spring, I refinanced my home with a new lender. It took less than thirty days to process my loan. Why? I provided all the documentation that was asked for up front with the application. If a borrower provides all the statements, taxes, paystubs, and other documents that the lender asks for to process the loan, their loan approval answer can be had very quickly. The thing that holds most loan approvals up is a lack of documentation. I have waited weeks for some clients to provide the required documents. If a person waits too long they may miss their window of opportunity for the interest rate. A rate “lock in” is where your interest rate is reserved for a fee paid to the lender. If a borrower is not forthcoming with the required documents in a timely fashion, the borrower may lose their preferred rate and the fee they paid for the interest rate lock in. Best advice, do your homework, research the rates, and have your documents prepared before you start getting serious.

Also, consider getting “pre-qualified” or “Pre-Approved” by your lender. Pre-Qualification will help you determine how much home you can afford, and what type of home you should be looking at. Pre-Approval will do the same, but will include a review of your personal credit. Lender’s often charge a small fee for Pre-Approvals.
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If you are interested in purchasing a home and wish to get Pre-Qualified or Pre-Approved, please see Meriwest Mortgage’s website  or contact them at 1-800-364-6636. Today’s rates are available here.
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For all of you out there looking for our next financial education workshops, your summer wait is over. Our next workshop will be "Reality Based Budgets for Teens" at our Milpitas Financial Center at 6PM on Aug. 22nd. 

Our next "Credit Myths and Repair Workshop" will take place at our Milpitas Financial Center on Aug. 29th at 6PM. 

I hope I will meet you at one of our seminars! Have a great week!

Thursday, August 9, 2012

Benjamin Franklin's Legacy of Money Management

Benjamin Franklin is probably the Founding Father who was most financially aware. I have assembled some of his more memorable lines here and added my own explanation to them. As you read these quips, remember the age in which these were written. Back in the late 1700’s, it was frowned upon when one borrowed. Both Shakespeare and the churches warned people against lending and borrowing money.

Let’s keep in mind, in 1785 there were no consumer lending laws to protect us from predatory lenders. As more than two hundred years have passed since Ben was publishing his thoughts on financial education, there have been numerous changes in how we borrow and how lenders work with us. Today, borrowing to purchase a home or a car is fully acceptable. When credit is granted, it is done through a very careful approval process where a borrower’s income and past credit management is put under scrutiny.

But, just like in Ben Franklin’s time, it is not a good idea to go too far into debt

Let’s consider some of his sayings:

When you run in debt; you give to another power over your liberty. -  And  - The borrower is a slave to the lender, and the debtor to the creditor.
Meaning that when we are in debt, those who hold our debt control us and take away our freedom to a certain extent. While in debt, we are slaves to the monthly payment!

Rather go to bed supperless than rise in debt.
Franklin had a great disdain for being in debt. In those days, if you were in debt, the whole town knew it. He would rather be hungry than owe money.

Tis easier to suppress the first desire than to satisfy all that follow it.
This relates directly to “Wants vs. Needs.” Essentially he is saying, fight the urges to spend money. As you fight those urges, it will be come easier and easier to suppress the desire to spend.

For age and want, save while you may; No morning sun lasts a whole day. 
Save for your retirement and for the things you want. Start now, start early. There is no time like the present to begin. You have a limited amount of time to make a good return on your retirement funds.

Get what you can, and what you get hold; ’Tis the stone that will turn all your lead into gold.  
It seems that Ben Franklin also understood time and money. Saving your money in an appropriate investment can turn a few dollars into many or “what you hold into gold!”

Beware of little expenses; a small leak will sink a great ship.
Little things add up. It’s like two sodas from the coke machine everyday. .75 cents per coke, twice a day, five days a week, for fifty two weeks = $360! Could we find a better way to spend or save $360?

Buy what thou hast no need of, and before long thou shalt sell thy necessaries.
If you buy the stuff you want you may eventually have to sell the important things you need to pay for the stuff you want.

All of these things are as true today as they were 230+ years ago. It is not a good idea to go into debt. It is still a good idea to save. It is still a good idea to invest. It is a good idea to have a budget and adhere to it. This is timeless advice that we can all use.

But let’s also remember that not all debt is bad! There is debt that can help us. A loan on a home allows us to write off the interest that is paid annually, thus saving families thousands of dollars in hosing costs making that home more affordable for them. A car is a personal asset that gets us to work on time. So, a car loan can be considered part of an investment in our personal economic development. 

And for all of you out there looking for our next financial education workshops, your summer wait is over. Our next workshop will be "Reality Based Budgets for Teens" at our Milpitas Financial Center at 6PM on Aug. 22nd. 

Our next "Credit Myths and Repair Workshop" will take place at our Milpitas Financial Center on Aug. 29th at 6PM. 

I hope I will meet you at one of our seminars! Have a great week!

Friday, August 3, 2012

Living at Home Again: Financial Advice for recent Boomerang Kids

Recently I had an email from Bill H. who is a recent college graduate but was unable to find a job immediately in the current job market. He turned up on his parents’ doorstep like many other recent grads. This is often referred to as the Boomerang Effect: students returning home after college rather than striking out on their own right away. Often, this is not by choice; the student would rather be working and on their own.

He wrote:

Dear Credit Union Guy,

After graduating I had to move back home until I find a job. Do you have any tips for managing my finances at this stage in my life?

Bill H.

Dear Bill,

Here are some points for you and other Boomerang Kids:
  • Don’t take on any new debt while unemployed! Save your money to make the payments you need to make on any current student loan, car loan debt or credit cards.
  • Don’t ever use a credit card for entertainment purposes while unemployed. I have seen far too many pizzas, movies, and concerts on students’ credit cards. They have nothing to show for this debt that they are paying it off at 19%! Ouch!
  • Make all your payments on time. Late pays will show up on your credit report and many employers use a credit report to determine the personal responsibility of potential new employees. Current payments mean you will get out of the house soon. 30 and 60 day late payments may cause you to sleep in the bunk bed with your little brother for a while longer than planned.
  • Maintain your checking account, make regular deposits to cover your outstanding checks and debit card charges. If your account goes into a negative balance, get it positive quickly. Most financial institutions will only maintain a negative checking account for 30 days. Then they close it for cause and report any losses to a collection agency and ChexSystems, a credit reporting service for financial institutions. If you get reported to ChexSystems by your bank or CU, a ChexSystems record will prevent you from opening a new checking account at a member institution for the next five years! Most banks and credit unions are members of ChexSystems. Trust me, you don’t want your parents seeing mail for you from ChexSystems and collection agencies. That does not make for pleasant dinner conversation.
  •  Make sure you have the address of your student loan company and the payment due data for your loan. Generally, six months after you graduate you have to start paying your loan. If you are not employed, you can ask your student loan company for a deferral in payment; this is known as forbearance. Interest will still accrue on the loan and be added to the balance, but payments will be deferred for six more months.

Bill, you are not the first kid to come home after college and you won’t be the last. Returning to home after college can be a stressful situation for students and their families. It is not what you expected to do when you finished your college degree and it is not what your parents expected either. But you can make the best of a difficult situation.

Don’t let your finances become a regular topic of conversation at your family’s dinner table. While living at home and looking for your dream job, don’t overlook getting a part time job to make some ends meet. A little bit of income is better than no income at all and it helps pay your bills. Manage your debt well and keep on top of your checking account. In the end, you will be respected for handling your personal finances in a very mature manner.

Best of luck,
The Credit Union Guy

And for all of you out there looking for our next financial education workshops, your summer wait is over. Our next workshop will be "Reality Based Budgets for Teens" at our Milpitas Financial Center at 6PM on Aug. 22nd. 

Our next "Credit Myths and Repair Workshop" will take place at our Milpitas Financial Center on Aug. 29th at 6PM. 

I hope I will meet you at one of our seminars! Have a great week!