Throughout 2009, consumers have become savers. The same people that refinanced their houses to pay for vacations, cars and furniture, now use extra money to pay off credit card bills and pay down second mortgages. This behavioral change will have an interesting effect on credit ratings and the way people view their credit scores.
Credit Scores and Saving
Acts of saving inherently increase credit scores. Consumers that pay down debt or that show substantial savings can increase their credit score significantly. Consumers, who find themselves with extra money, should always pay off high balance, high interest revolving accounts like credit cards and store accounts. While many experts suggest leaving these accounts open, many times the extra benefit to credit scores outweigh the hassles of paying annual fees or inactive fees.
After paying down revolving accounts, consumers should look to second mortgages or home equity loans. These loans typically have higher balances and lower interest rates than their revolving counterparts. Even if consumers cannot fully repay these loans, reducing their balances has positive effects on credit scores over time. Keep in mind, as total debt outstanding is lowered, credit scores rise.
Credit Scores and Loan Modifications and Defaults
Many consumers also face the challenge of modifying or simply defaulting on their loan. Either road will result in a negative effect on credit scores. Defaults typically include late payments and an ultimate judgment against the borrower. These could deflate a credit score by 300-400 points. Loan modifications may include late payments and will most likely include some time of debt reduction or payment reduction. These could lower a credit score by 50-200 points.
It is important to note that although mortgage issues will certainly affect borrowers’ credit scores, many financial institutions are not penalizing these borrowers as harshly as they would have in the past. A foreclosure or modification might only leave a borrower paying a higher interest rate until it falls off the report today, while it would have been an automatic denial in the past. Borrowers with foreclosures on their records should expect to be out of the market for two to three years, but should be able to obtain a mortgage after that time.
Consumers should remember that credits scores are simply tools to obtain financing. Like any tool, it must be properly maintained when not in use to provide the necessary support when needed. During these times of saving, paying down debt and putting money away for a rainy day will not only make consumers more financially sound, but it will also increase their credit scores.
Michael Cook - Michael Cook is currently a Real Estate Investment Banker for Wachovia. He and his partnerstarted their own real estate investment ...
