An Excellent Credit Score - Why You’ll Really Need it Soon

How to get excellent credit is a question that’s been on the minds of the fiscally astute for a very long time. These people know the importance of having golden credit, and how it can facilitate numerous transactions and save you money. Before long however, having an excellent credit score will be a virtual requirement if you want to do something as previously simple as get a credit card.

To those Americans raised on the concepts promoted by the credit industry for the last decade, i.e. "Get a credit card into the hands of every consumer." this shift in lending policy may seem a bit strange. In reality, it’s merely going back to an era of much more conservative lending guidelines. In the minds of many economists and money managers, the shift away from these more conservative fiscal rules has contributed significantly to the financial problems that began in 2006 and have gotten worse since.

This may actually be more than just a swing of the pendulum back to to traditional credit requirements for consumer lending. In fact, consumer credit may virtually dry up for all but the most credit worthy, and business credit, even for very large companies, may be much harder to secure. Why is this new credit crunch happening?

There a multitude of reasons. One is that the entire financial system is in part, a house of cards built on investor confidence. If that confidence is shaken, the house begins to tumble. Credit is backed by investment. Investors, be they large institutional investors such as pension funds or mutual finds, or smaller individual investors purchase the securities that underlie much of the credit products we’ve used for the past 2 decades.

This investment in credit can be done directly, when the investors purchase bonds or other credit backed securities, these are known by the term "asset backed securities", or ABS. ABS are serviced by credit receivables such as credit card and loan payments. Investment in the credit markets can also be done indirectly, such as when they buy stock in financial services firms that provide credit, such as Visa, GMAC or Chase. The larger percentage of credit based services a firm provides, the greater the effect unrest in the credit markets will have on it.

Both shareholders and other investors in the credit markets demand a return on their investments. After all, these investments are the pensions, retirement funds and college funds of you and your neighbors. If investors feel they may not get the return they deem necessary for the amount of risk they’re exposed to, they will park their investment dollars elsewhere. This relationship between risk and reward is why those people with lower credit scores pay higher interest rates on their debt.

When investors get skittish about the security backing their investment and begin to move their money into other forms of investment it does two things:

1) It increases the cost of credit because the interest rate goes up in response to the perceived increase in risk exposure. When interest rates are higher, some investments are more attractive, but other parts of the economy are hit hard, as investment in assets that create productivity, such as plant and equipment, vehicles, and production inventory get more expensive. Sales inventories, such as the consumer goods which many merchants buy on credit become more expensive. This causes merchants to raise their prices to the extent they are able without adversely affecting profits. Consumers also buy less because consumer credit is more expensive.

2) It also decreases the availability of credit because there simply isn’t as much money in the credit pool. Without money to lend, creditors obviously can’t make loans or extend lines of credit. This credit tightening affects both consumers and businesses. Consumers have difficulty financing purchases, especially of large ticket items. Businesses hove more difficulty finding financing for inventory, displays, plant and equipment, and seasonal labor, among other things. Here is where credit is really the financial grease that keeps the economy moving.

In the most recent problems, the problems in the mortgage industry were caused as property values fell in many markets. Foreclosures increased as the creative financing used by many borrowers with insufficient financial means demanded larger monthly payments. The lower real estate values meant that the properties could no longer be refinanced with traditional mortgages, with their lower monthly payments. Foreclosures soon followed for a much larger than normal number of borrowers.

The combination of the high foreclosure rate and sinking property values meant that the collateral backing many of the mortgages was insufficient to secure the loans in the event of foreclosure. This meant that the investors would lose money when the properties were sold to satisfy the foreclosure. Many of the mortgages, especially the higher risk, and thus higher return mortgages were packaged as securities called collateralized debt obligations. These investment products were sold to large, mostly institutional investors in the United States and overseas.

The carnage soon spilled over from the mortgage industry into the other credit markets. In some cases banks have even become less willing to lend money to other banks, fearful that the borrowing bank’s asset base wasn’t stable enough to allow the loan to be repaid, or that decreases in the value of their portfolio would soon render them unable to meet their obligations from regulators and depositors. The widespread credit problems caused or will soon cause some major economic problems for reasons detailed below.

Credit’s major function in the modern economy is as the financial lubricant that facilitates many of the transactions that occur in both the consumer and business world. The availability of credit keeps business getting done, and keeps the economy growing, as businesses use credit as leverage to create wealth. They expand payrolls, hire employees, purchase inventories and means of production, and engage in research and development, all using credit.

The shaken investor confidence in both credit and the economy as whole could easily foster a situation whereby credit becomes severely restricted. Credit will simply cease to become available for all but the most extremely credit worthy. This will happen for both consumer credit and business credit. If this restriction occurs, as it is already showing unmistakable signs of doing, the world’s economy could grind virtually to a halt. The U.S., with its high reliance on credit, stands to be one of the hardest hit economically.

Here are some statistics that point to troubles on the horizon, a horizon that seems to be moving inexorably closer. According to the U.S. Federal Reserve G-19 report for October 2008, non-revolving consumer credit (this is the type used for homes, cars, and boats) for August fell at an annual rate of 5.4%, after showing only a .9% gain in July, of from a 4.6% annual rate increase for June of 2008. Since U.S. consumers have been averaging between 4% and 5% for a while, this drop means one of two things; either Americans have suddenly lost their taste for credit, or they can no longer get credit.

Because the odds are slim that the consumerist society that is the United States of the last 25 years magically decided to steer a course of financial restraint and fiscal responsibility, the odds are good that credit has gotten tougher to qualify for. A quick look at the major credit markets reveals that that is, in fact, the case.

For consumers that means bolstering your credit score will be time well spent. Whereas in the past it was relatively easy to get credit no matter what your credit score was, that will no longer be the case. Foggy mirrors no longer mean automatic loan approvals. The money for such risky loans no longer exists, no matter how attractive the interest rate is for investors. No one will originate the loan, and part of the reason is that there is no one left to buy it.

In days of yore, the majority of loans weren’t serviced by the lender who originated the loan. Most would be sold in a process known as "selling the paper". That brings in a shot of fresh capital to begin the lending process anew. It also provides such niceties as salaries, insurance, and office rent. The problem these days is that there a fewer buyers for these loans, either individually or when they’re bundled into mortgage or other debt backed securities.

So, as move forward into what could prove to be those dreaded "interesting times" an excellent credit score may well be just what you need if you want to buy a home, or that fancy, new Mustang Bullit you saw on your way home from work yesterday. To make these transactions happen you’d better be in the upper echelon of borrowers or you’ll probably find yourself on the outside, looking in.

How to Increase Your Credit Score Yourself
Most of the things that hel raise your credit score you can do yourself. You can hire a pro if you feel more comfortable, but for many people that's not completely necessary.