In developing countries, a tiny loan can make a huge difference. A woman who can borrow $100, for example, can buy a sewing machine and make clothing to sell, lifting her family out of poverty.
- Quick quiz: 10 questions to estimate your credit scores
Clearly, credit properly used can transform lives. Some have called access to credit a basic human right.
The other side of the coinBut credit too freely given nearly wrecked our economy. Unaffordable mortgages plus soaring unemployment have led to a raft of credit ills. Bankruptcies are rising, foreclosures have hit record highs, and credit card defaults approached 10% this spring.
As a result, 26% of Americans with active credit accounts have credit scores of 599 or below, too low to qualify for most mainstream lending. That compares with 15% pre-recession.
In all, nearly 18 million people have joined the ranks of the credit pariahs since the recession began.
- Pay more for insurance, because auto and home insurers use credit scoring to determine premiums.
- Have trouble getting apartments, because landlords often check credit scores.
- Have to make large deposits to get utility services.
- Have trouble getting cell phone contracts.
A spotty credit history can cause trouble in another way: by making it hard to find a job. Many employers use credit histories (although not credit scores) to evaluate applicants.
So the question is: Are the people with sub-600 scores paying too high a price for a crisis that was beyond their control? Should lenders (or the government) take steps to make credit available to them? Should we, in other words, have guaranteed access to credit?
I think not. Employers need to be stopped from using credit information for most hires, because many are applying that information unfairly. But cutting people off from credit when they fall below certain scores isn't unfair. It simply reflects the reality that they were given credit and bungled it.
Maybe it wasn't entirely, or even partly, their fault. Even people who have borrowed prudently and tried to save money can get knocked off track by long-term unemployment. The average duration of unemployment in June reached a shocking 35 weeks, or about eight months.
But one of the things that got us into this economic mess was a refusal to acknowledge that people who mess up their credit shouldn't instantly be given more. That, and some people can't handle credit -- period.
A house for everyone?Dan Ray, the editor-in-chief of CreditCards.com, remembers a business writers conference several years ago where a Freddie Mac official touted a homeownership rate that peaked at 69% in 2004.
"I asked, 'Isn't there an upper limit? Aren't there some people who can't handle a mortgage?' She said, 'Nope, no upper limit, the more the better,'" Ray recalled. "Clearly, that was wrong."
Not everyone is financially stable enough, or responsible enough, for a mortgage. But lenders ignored that fact in their rush to make loans they could then sell to Wall Street investors. Borrowers ignored it, too, in their haste to buy into rising home prices.
You should have to show some evidence you have your financial act together before you get a six-figure home loan. Evidence such as:
- Good credit scores, showing a history of responsible credit use and on-time payments.
- A provable, reasonably steady income so you can make the payments.
- A decent down payment, plus a stash of cash left over after closing to take care of the inevitable repairs that will pop up, to show you have the discipline to live within your means.
At the peak of the mortgage boom, lenders made some loans without any of those criteria. Creditworthy borrowers often got loans for insane amounts, given their incomes, predicated on the idea that they would be able to refinance into another loan before the low introductory rate spiked.
Some sanity has returned to the mortgage markets since the crash. The most toxic mortgages -- interest-only loans and "pick a payment" option ARMs that allowed borrowers to pay even less than the interest owed -- have disappeared, at least for now. Lenders actually make sure the income borrowers report to them matches what's on their tax returns.