Shakespeare's famed line from Hamlet, "Neither a borrower nor a lender be," never seemed more fitting.
As the worst financial crisis in decades has taken hold, banks have put the squeeze on all sorts of consumer loans. They're taking steps to ease their risk, as unemployment rates climb and the number of delinquent borrowers swells.
If you want a new home or a new set of wheels and have less-than-stellar credit, you might have a hard time finding a lender and a decent rate. "The bar has been raised on who gets the very best rates," says Greg McBride, senior financial analyst at Bankrate.com.
Lenders are ratcheting up minimum credit scores, requiring heftier down payments and upping interest rates for borrowers with less-than-pristine credit histories. The end of easy money has arrived, and lenders nationwide are ready to help you learn how to live within your means the hard way, by not lending you any more dough until you prove you can pay it back in a timely fashion.
As the ever-wise Shakespeare penned, "Put money in thy purse."
Being a Good Borrower
For most, an unblemished credit score and a steady paycheck will make landing a loan no more difficult than in years gone by. "You need to be financially fit and have the documents to prove it," McBride says.
"Yes, the credit environment has changed," acknowledges USAA Federal Savings Bank President David Bohne, "but our bank is strong and we continue to help members meet their credit needs. If you have a good credit history, we'll offer you the best terms we possibly can."
By far, the biggest change in the credit environment is what lenders consider a good FICO credit score. That's the three-digit number, generally ranging from 300 to 850 and devised by the Minneapolis-based Fair Isaac Corp., that often determines whether you'll get credit and at what interest rate.
The New Ideal
The credit-worthiest borrower a year ago was someone with a 680 to 700 FICO score. Now it's someone with mid-700s and up, McBride says.
It's not that Fair Isaac has changed how it calculates the score. It's that lenders are looking for higher numbers than they did even six months ago. "Essentially, your credit report had better be as good as it possibly can," says Carol Kaplan, a spokeswoman for the American Bankers Association. That said, every lender has "its own standards, so there is no one specific credit score that means you're scot-free."
But in general, scores need to be at least 50 and often 100 points higher than they needed to be a year ago to get the best rates, Kaplan advises. If you're shopping for a loan, here's what to expect.
Mortgages: The basics are back.
"Gone are the days when breathing was enough to qualify to get a mortgage loan," says Keith Gumbinger of the financial publisher HSH Associates, which tracks rates on mortgages and consumer loans. "We're back to a more normal credit environment for mortgages."
Loans still may be available for those with scores as low as 620 or perhaps lower, but you'll pay for it with a much higher rate, say, more than 10 percent versus around 5 percent for a 30-year, fixed-rate, $300,000 loan.
In addition, to show you have the wherewithal to pay, lenders are eyeing an overall debt-to-gross income ratio that falls below 40 percent. That's down from the 55 or 60 percent that some lenders approved before the mortgage meltdown, Gumbinger says. The maximum ratio to qualify for a VA loan is 41 percent. Even if a lender does not hold you to this, you would be smart to do so yourself.
And you'll need cash for a down payment. "Lenders want you to have skin in the game," he observes. The amount is creeping back to 20 percent for the best rates, but plan on putting down at least 10 percent. Lower amounts are still available on Federal Housing Administration loans, if you qualify. Moreover, you will need the paperwork to prove your income, assets and overall balance sheet.
Borrowers looking to refinance with reasonably good credit and a home that hasn't lost too much value will find ample mortgage money. But to qualify for the premier rates, those refinancing need to have pristine credit and at least 10 to 20 percent equity in their homes.
Auto Financing: Expect tougher financing
"The credit market is definitely tighter now than it was a few months ago, but credit is still available for car shoppers," says Jesse Toprak, an industry analyst at automotive information website Edmunds.com. "The key is, if you qualify. Those with good credit histories can still get the car and the deal they want and terms just as favorable as ever."
Interest rates currently range from 0 percent financing for borrowers with excellent credit up to more than 16 percent for a borrower with a score in the 500s. The national average rate for a borrower with a 720 score is now 6.68 percent on a $25,000 loan amount.
And down payments are back. You'll probably need a score of 700 or above to finance a car without a down payment, up from 650. Borrowers below that score might be asked to pony up as much as 20 percent in cash. But lenders are even requiring consumers with average credit scores to throw in at least 5 percent, and more frequently 10 or 20 percent.
And lenders are restricting the length of loans. So for many consumers, signing up for a loan that's longer than five years, a common practice the past few years, might not be a choice.
Credit Cards: Fewer offers for 0 percent balance transfers
Card companies have been reducing credit limits, raising interest rates and fees and closing idle accounts in response to rising business costs and charge-offs, which occur when banks treat delinquent accounts as a loss. "Days of a $25,000 credit card limit with a credit score in the 600s are gone," says John Ulzheimer of Credit.com, a consumer credit information and application site. "Getting approved for a new credit card is definitely more difficult, but it's not Armageddon, as some people say," he adds. "As with other consumer loans, it's all about your credit score. Try to get it well above 700 for the best deals."
The big danger from a credit picture perspective is having a credit card's limit reduced or closed for non-use, Ulzheimer observes. Reducing credit lines has hurt some consumers by affecting their debt-utilization ratio, which is the percentage of available revolving credit they're using on credit cards. A high debt utilization can lower a credit score, which then makes it tougher to get credit, or at least get credit under favorable terms. Make a habit of using each card once every six months at least, and then pay the bill before the grace period expires and you start to owe interest.
Old credit vs. new credit standard
|Best credit score||680 and up||720 and up|
|Down payment on a house||0 to 10 percent||10 to 20 percent|
|Total debt-income ratio||55 to 60 percent||Less than 41 percent|
Source: HSH Associates, hsh.com.
Kerry Hannon is a freelance financial journalist, author and speaker.