Ah, credit. The nation’s widespread adoption of it has allowed several generations of Americans to spend beyond their means, creating more car owners, college students and homeowners than ever before. Of course, buying on credit also has its drawbacks, the primary one being the amount of interest that borrowers must pay on their credit purchases, which ends up increasing the overall cost of that car, student loan or home.
Despite its drawbacks, the nation’s use of credit has increased each subsequent decade since it first became commonplace during the 1920s, according to data published by the New York Times. For example, 40 percent of U.S. households currently carry a monthly credit card balance, compared to just 6 percent in 1970. Also, two-thirds of today’s college students have student loan debt; only 50 percent of college kids did a decade ago.
Today, using credit to pay for things is not just commonplace, it’s the status quo. Due to last year’s financial meltdown, however, lenders will be playing hardball with consumers in 2009, enforcing stricter loan approval terms that require borrowers to have higher credit scores and lower debt ratios. To give you a head’s up for the year ahead, here’s an overview of stricter loan qualifications to expect:
To get the lowest rates, you’ll need a credit score of at least 740. You can still get a mortgage with a lower credit score, but you’ll pay more for it. You’ll also need to keep an eye on your overall debt ratio if you’re in the market for a mortgage loan. Starting Feb. 1, 2009, Freddie Mac will only lend to borrowers with an overall debt ratio at or below 45 percent of their pre-tax income.
If you plan to apply for an FHA loan, your overall debt ratio must be at or below 43 percent of pre-tax income, and your mortgage debt-to-income ratio can’t go over 31 percent. Even though the new mortgage loan requirements demand lower debt ratio thresholds from potential borrowers, they still generally qualify as generous lending terms. According to The Motley Fool, the typical debt-to-income ratio accepted by lenders is 25 percent. Furthermore, the site advises consumers to maintain an even lower debt ratio equaling 15 percent or less of after-tax income.
Home-equity loans and home-equity lines of credit
To be approved for one of these, a credit score of between 650 and 680 used to do the trick, but no more. Now you’ll need a score of at least 680 to qualify, and some lenders won’t consider potential borrowers with a score under 720.
If you’re looking to buy or lease a car this year, you’ll need a credit score of 700+ to guarantee financing. You may be able to get a loan with a lower score, but you’ll probably be required to make a higher down payment and may also be forced to accept a shorter-term loan (36-48 months versus 60-72 months).
In addition to your credit score, also keep in mind that credit unions can offer better financing options than banks. One recent survey found that credit unions had average car loan interest rates of 6.4 percent, while banks had average rates of 6.6 percent.
Private Student Loans
For college students not eligible for federal student loans, or who need to supplement their federal student loans with private funds to cover college expenses, a credit score upwards of 650 is required in order to qualify for a private loan. Don’t have an established credit history? You’ll need to bring along a co-signer with a decent one in order to secure a loan.
The credit card companies have decided to raise their standard for good credit in 2009, in some cases demanding credit scores of 740-750 for the privilege of charging your next purchase to their piece of plastic. A word to the wise: Make sure your credit card balance stays under 30 percent of the credit limit. Going above this amount may lower your credit score and increase your interest rate. Even worse, it may cause other issuers to raise your credit card rates, which is still legal until mid-2010 when the Federal Reserve Board’s new credit card rules take effect.
In addition to the changes listed above, a new FICO credit scoring system is also set to take effect sometime in 2009, according to a recent Kiplinger article. The new system could affect up to 50 percent of consumers, potentially raising or lowering their credit scores by more than 20 points. No matter how you slice it, 2009 will prove to be a rocky year for borrowers of every stripe.