What’s Behind A Credit Score?

I was a 21-year-old father with #2 on the way. My car needed costly repairs; I needed a reliable vehicle to get to work. My mother suggested I apply for a loan at the local bank in town.

Mrs. Z, a long-time family friend, was the head teller and smiled when I walked in. I explained the situation. She helped me fill out a loan application for her to take to the loan committee for approval, and call her in the morning.

I was worried, fretting about overweight bankers, with vests and pocket watches, debating whether they should lend a few hundred dollars to a 21-year-old for a car.

My credit history consisted of a few months of mortgage payments. Our tiny prefab home was $99 down, $102/month, half the income from my primary job. If there were credit scores, mine would have been bleak; I had little credit history.

Things were different. It took years before I understood what probably happened.

Mrs. Z was my mother’s best friend, they were each other’s maid of honor. If I could find my baptismal records, likely she was my godmother. I’d guess she went into the manager’s office, told him the situation, I was a good kid; she vouched for my credit. So much for the “loan committee.” Decades later I asked her about it. With a huge grin, she said she didn’t remember.

What’s A Credit Score?

For months a medical provider has incorrectly billed me. Each month I contact them, they acknowledge I am correct, they will fix it; yet next month I get another bill.

A recent email mentioned a change in my credit score. The medical provider probably reported I have a past due balance. Why should I care? The only credit we have is credit cards, we pay in full and enjoy nice rebates.

Investopedia tells us: (emphasis mine)

“The credit score model was created by the Fair Isaac Corp., now known as FICO….

The three major credit reporting agencies in the U.S. report, update, and store consumers’ credit histories. …. Five main factors are evaluated when calculating a credit score:

• Payment history

• Total amount owed

• Length of credit history

• Types of credit

• New credit

A credit score can significantly affect your financial life. It plays a key role in a lender’s decision to offer you credit. …. Lending institutions often charge interest on subprime mortgages at a rate higher than a conventional mortgage to compensate themselves for carrying more risk.

…. While every creditor defines its own ranges for credit scores, the average FICO Score range is often used.

Excellent: 800-850

Very Good: 740-799

Good: 670-739

Fair: 580-669

Poor: 300-579″

Business Insider published a chart showing mortgage rate averages by FICO score:

The Balance outlines just how much a credit score can “significantly affect” a borrower. Note the loan is for $200,000, the gap would be greater if the amount was larger.

Credit scores are tools for assigning interest rates for all borrowing. The lower the score, the higher default risk; therefore, the lender charges more interest to compensate.

What about the human factor?

I’m perplexed with this entire process. I don’t see anything about net worth; it appears savers are punished. What about my loan years ago, the bank bet on me, a hard-working kid who was working three jobs to support his family?

In my 30’s I built a relationship with a manager of my local bank. He knew me, my family, my history, and gave me a personal line of credit. A simple phone call made money readily available …. no questions asked.

Today online lenders check your credit score and you can get a loan almost instantly, with little human interaction.

I contacted Chuck Butler, a former banker, and asked for some input.

He said the banks he worked for looked at several factors:

• Can they repay the debt?

• What is the collateral?

• What is their future earning potential?

• What is their history?

Chuck triggered my interest in his article, “Come get your car loan, you won’t have to pay it back!” He discusses inflationary effects in relation to car loans. He shares some ZeroHedge information along with his conclusion:

• “‘Are We Headed For An ‘Auto Loan Crisis’ As Delinquencies Begin To Rise? – July 7

• A Flood Of Repossessed Vehicles Poised To Hit The Used-Car Market – July 25

• American Drivers Go Deeper Into Debt As Inflation Pushes Car Loans To Record Highs – Aug 29

• Credit Card Rates Just Hit A Record As The Average Car Loan Rises To Fresh All Time High – Oct 9

• New-Car Loan-Rates Set To Hit 14-Year High As Affordability Crisis Worsens – Nov 3

• Perfect Storm Arrives: ‘Massive Wave’ Of Car Repossessions And Loan Defaults To Trigger Auto Market Disaster, Cripple US Economy – Dec 18

“Credit expansion is not a nostrum to make people happy. The boom it engenders must inevitably lead to a debacle and unhappiness.” — Ludwig von Mises

So while the big picture is clear – Americans are using ever more debt to fund record new car prices.

…. A soaring number of consumers are falling behind on their car payments – a trend which will only accelerate – in a sign of the soaring car prices and prolonged inflation are having on household budgets.

…. In recent months, the number of people behind on their car payments …. and for the lowest-income consumers, the rate of loan defaults is now exceeding where it was in 2019….

…. A newer report from Fitch has laid out an even more startling milestone: more Americans are falling behind on their car payments than during the financial crisis.

Chuck again… Yes, these defaults usually start with the small stuff, and then one day, Whack! One Big Boy defaults, and then the dominoes begin to fall… I’m just saying…”

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Hang on a minute!

I asked Chuck, “When the music stops, who gets stuck with these bad loans?”

He said, “Generally the lenders package the loans and sell them, along with the default risk. The real big boys, the investment banks, sell the loans as income products, touting them as safe investments to yield starved customers, pension funds and 401k’s.”

In other words, the credit score has two purposes. First to enable lenders to charge more interest to consumers with questionable credit. While the lenders say higher rates are necessary; they really don’t care; they sell the loan/risk to others. I’ve noticed many lending institution advertising ways for consumers to boost their credit scores. Hmmm……

The overall credit scores helps investment banks peddle their products to investors, creating the illusion of safety from default. We learned in the mortgage crisis, the underwriters were in cahoots with the banks, often giving these investment packages ratings they did not deserve.

Half-jokingly, I asked Chuck what credit score he would give the US government. He answered the question seriously, referring back to his four points:

“Can they repay the debt? I don’t see how it is possible to pay off $32 trillion in debt, coupled with rising interest rates and over $100 trillion in unfunded promises.

What is the collateral? Their ability to tax. How much can the hard-working Americans bear? Over half the population is already on the government dole.

What is their future earning potential? Unless our economy miraculously grows, and congress curtails unnecessary spending, I don’t know. Interest on current debt is really going to cause problems down the road.

What is their history? Oh, they won’t default. This is what concerns me…. Historically they will try to inflate their way out of debt. Our currency will become worthless in the world market. Personally, I can’t see the government allowing interest rates to revert to honest, free market rates.

Our major creditors, Japan, Russia and China have stopped lending us money. I can’t understand why the media isn’t picking up on the Saudis no longer requiring petrodollars.

The Fed is trying to fool the world into thinking they are serious about taming inflation. Our creditors aren’t buying it, our credit score doesn’t equate with current interest rates; particularly when they look at the potential for higher inflation. To continue borrowing we will have to raise interest rates to make our debt more attractive.”

Tying it all together

I’ve said before, get out of debt; renting other people’s money is expensive. Investors are lenders, not borrowers. Credit scores of prepackaged loan investments should be looked at cautiously. If your advisor has put together a portfolio consisting of several of their fee-based funds holding loans, be very wary.

If Michael Burry of “The Big Short” looks under the hood(pun intended) of these car loans he’d likely find the packaged loans are a lot riskier than we think. Expect defaults to continue to rise on both corporate and personal debts. While I wouldn’t short them as Burry did, I don’t want to own them either.

I’m wary about owning any debt, particularly long term. Defaults are going to rise, and I’m not convinced that inflation is going to be under control any time soon.

Gold and tangible assets should take a higher priority over holding dollar denominated debt instruments. Don’t get caught like millions of investors did in 2008….

A little help means a lot! Eight years ago, I vowed to keep our newsletter FREE! I plan to keep my promise. It’s an expensive, time-consuming hobby, but also a labor of love. Recently a reader asked why I didn’t charge for our weekly letter. I explained that I want it available for everyone. Some readers may be on limited budgets and may benefit the most from our advice. He pressed on with his questions. How much does your letter cost? How many readers do you have? He concluded, “If each reader paid $10/year, you would be fine. I responded, “Yes, $10 per reader would work, BUT I am committed to keeping it FREE even if it costs me money.” Several readers suggested we add a donations button to help us offset the cost of our publication. It helps when people pitch in and we certainly appreciate it. If readers want to donate, it sure helps out, however, it’s strictly voluntary – no pressure – no hassle! Click the DONATE button below if you’d like to help. You do not have to sign up for PayPal to use your credit card. And thank you all!

On The Lighter Side

Last week I spent a fun couple of hours in the warm afternoon sun on the observation deck at the Deer Valley Airport. It’s one of the busiest general aviation airports in the country.

With the Super Bowl and a major golf tournament in town, a larger number of private jets were on the ramp.

I have the FlightAware app on my phone, which is fun. Planes were crammed everywhere. On Friday the plane in the foreground flew from Philadelphia to Boca Raton and on to Phoenix. You know who they were rooting for in the Super Bowl.

After last week’s living from Paycheck to Paycheck article…. Chuck mentioned in his Daily Pfennig (If you haven’t signed up for this already, I highly recommend it!) I saw this on Bloomberg… “over half of Americans making over $100K are living from paycheck to paycheck.”

Geeesh! I find that really sad; hopefully these folks can work their way out of debt and build some net worth….

Subscriber Zeus sent me a video that will hit home with most everyone. It’s short, entertaining, and sends a powerful message; you will laugh and cry. Click HERE.

Quote of the Week…

“One does not walk into the forest and accuse the trees of being off-center. Nor do they visit the shore and call the waves imperfect. So why do we look at ourselves this way?”  — Tao Te Ching

 

And Finally…

Friend Alex N. shares some clever thoughts:

• Did you ever wake up in the morning, look in the mirror and think.…”That can’t be accurate?”

• Last night the internet went down. I spent a few hours with my family. They seem like nice people.

• Weight loss goal. To be able to clip my toenails and breathe at the same time.

• For those of you who don’t want Alexa listening in, they are making a male version…it doesn’t listen to anything.

• I just got a present labeled, “From grandma and grandma” and know darn well grandpa has no idea what is inside.

• The biggest joke on mankind is that computers have begun asking humans to prove they aren’t a robot.

And my favorite:

• When your kid says, “Mom, I think we should ask grandma”, does that mean, “I’d like to speak with your supervisor?”

Until next time…

Dennis Miller

“Economic independence is the foundation of the only sort of freedom worth a damn.” – H. L. Mencken

 

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