Re: The History of Credit
12-06-2011 06:56 PM
I'm not sure that you're understanding what my question is. My concern is that a lender will decide the interest rate on the debtor due to a low FICO score. A low FICO score, more times than not, indicate a person who is struggling with finances. A debtor may get desperate and think that more credit will help them out of their situation. Once they do this, they are approved and charged a large interest rate, all the while they are paying a minimum payment that will never get them out of debt.
My question focuses on the potential for abuse by new lenders to charge high interest rates on drowning debtors who are still able to attain credit (because they pay their minimum payments). Payment history doesn't catch a person who pays the minimum payment and cannot afford more credit. Payment history simply shows someone who can pay a minimum payment. Stopping new credit can prevent large debt from accumulating.
Thanks for the quick response.
Your solution to the problem although noble (well intentioned), would create the following situation. A person might be having a temporary set back and need to borrow more money but is willing to pay the interest, tighten his belt, work twice as hard, and work his way out of debt. He still needs operating capital to continue without defaulting on some bills and having his credit trashed for possibly 7 years. You would have the banks or society protect him from himself by cutting off all credit because he is STARTING to APPEAR like a risky borrower.
Cutting people off from credit at the early "risky" stage would be like telling them to default now and try to rebuild credit again in a few years. The existing system mitigates the risk that person might present to lenders who don't suddenly cut him off from credit. All people at his "risk" level, are pooled and charged a slightly higher interest rate so that the lenders are compensated for the 5% or so people (who are at his risk level) who will eventually actually default on their debts.
Some people work their way out of debt from the above mentioned level of risk, and eventually get somewhat lower interest rates. Others end up going deeper into debt and now have a higher chance of defaulting. At that risk level 10% of the pooled risks are projected to default so the interest rates are raised again to cover costs of the projected defaults. At some point some people do go all the way down the slippery slope to higher and higher interest and eventually BK.
At least under the current system people have choices. By trying to protect people from themselves presumably by more laws, one denies credit to people who only have minor setbacks and are willing to do what it takes to work out of debt.
Sure the system is abused, especially by the banks. It is however what it is. If we try to radically change it, the lenders will find new ways to maximize their profits. When that happens those who can least afford it will be hit with additional fees and higher ongoing interest rates.
The problem is not the lenders. It is human nature. If a person has financial misfortune and needs to cary any debt at all, that person should realize that living debt free should be the goal no matter what it takes. Temporary debt is necessary at times, and the interest rate incurred by temporary debt is relative low. Long term debt is simply a situation of the borrower being slave to the lender. The longer and deeper a person is in debt, the higher the interest cost.
I agree with your premise that lowering interest rates may help some people get out of debt faster. Unfortunately most will simply use the lower cost of borrowing to excuse racking up more debt. The banks are in business to make money, not help people out of debt.
Simply out the banks make money from people who pay them. A certain percentage will end up defaulting (not paying). The banks just play the odds. Lend to more people who will pay than won't pay. In the end FICO scores are just the "odds that a creditor will be repaid". At a race track you can bet on a favorite or a long shot. When a bank bets on a favorite with a high FICO score and low outstanding debt the bank is willing to accept a smaller pay off. If the bank is betting on a 100 to shot (low score high debt), the bank wants a higher pay off if it actually ever gets paid all that it is owed.