Let's start with the good news. You can still borrow money, whether it's a mortgage or a home-equity loan, a car loan or a student loan. But you'll find that the rules have changed. Your credit record and credit score matter more than they used to, and home and car purchases require bigger down payments.
In late November, the federal government announced two new programs to help kick start consumer lending. First, the Federal Reserve will purchase $500 billion of mortgage-backed securities. The news sent mortgage rates lower and generated a slew of calls to mortgage brokers. Part two is a $200 billion program to lend money to private investors who buy securities backed by student and auto loans, credit card debt and small-business loans guaranteed by the Small Business Administration. Theoretically, easier credit will trickle down from this program, but it may take a while before consumers see the effects. And neither program addresses the reluctance of lenders to take chances on any but the most credit-worthy customers.
You may get a better reception at the local branch of your own bank or at a smaller community bank or credit union. If you don't like the rate offered or you get turned down, keep shopping, says Keith Gumbinger, of HSH Associates, which publishes financial information and rates. "Price and access to money are widely variable. Just because a lender on one side of town says no doesn't mean it's no." Before you shop rates, request your credit reports and check your credit scores at annualcreditreport.com. That way, you can see where you stand -- and what may be dragging down your credit.
To get a mortgage now, you'll have to make a down payment and document that you have the income and reserves to make your mortgage payment, run your household and still handle unexpected expenses.
Subprime mortgages that were offered to borrowers with questionable qualifications during the housing boom have dried up because lenders -- and the investment firms that bought the mortgages -- can no longer count on appreciating home prices to bail out bad loans. Now most lenders (and borrowers) must play by the rules of Freddie Mac and Fannie Mae, which guarantee loans meeting their criteria so that investors will want to buy them in the secondary market.
Loans backed by the Federal Housing Administration have also regained favor as an option, not just for credit-challenged borrowers (typically those with credit scores under 620) but for prime borrowers looking for low down payments.
The FHA helped Kyle and Tracy Spear of Swampscott, Mass., north of Boston, purchase a larger home with a small down payment. Last summer, the couple had planned to subdivide their property in Boston and sell the home plus a separate lot. But the city and their neighborhood nixed the subdivision, and they ended up netting just $15,000 on the sale. For two months, Kyle, 38, Tracy, 37, and their three boys -- Kyle, 4; Tyler, 2; and Jack, 11 months -- lived with friends and family to save money until they found their next home, a 2,800-square-foot house with four bedrooms that cost $540,000. They qualified for a 30-year jumbo mortgage with a fixed rate of 6.875% backed by the FHA. And because the FHA required a down payment of only 3%, they had to put down just $16,000.
Prove it. The days of "Take my word for it" are over, and stated-income loans, or so-called liar loans, are history. Lenders will ask you for at least two months of financial account statements, two years of tax returns and even verification from employers that overtime, commission or bonus income will continue.
Lenders are also scrutinizing more carefully the ratio of your debt to income. Beginning February 1, 2009, Freddie Mac is imposing a limit of 45% of all pretax income for all debt; borrowers with a credit score of 740 or better will get the best rates. The FHA's guidelines are even more stringent: Mortgage debt may not exceed 31% of your income, and total debt can't top 43%. The FHA doesn't impose a credit-score threshold.
Loans with no down payment, or those that combine first and second mortgages, such as the 80/20, are also gone. Mortgages backed by Fannie and Freddie require a minimum down payment of 3% to 5%. The bigger your down payment and the better your credit score, the better your interest rate. If you put less than 20% down, you'll pay private mortgage insurance, or PMI. But here's the Catch-22: If home prices have been falling in your area, you may not be able to get PMI, and if you can, you'll have to ante up 10% to 15% for a down payment.
Congress has authorized the FHA, which relies on its own program of mortgage insurance, to take up the slack in declining markets, says Meg Burns, director of the FHA's Office of Single-Family Program Development. The FHA can guarantee loans up to the same amount as Fannie and Freddie. Beginning January 1, the limit is 115% of a metro area's median home price, up to $625,500, and the minimum down payment is 3.5%, up from 3% in 2008.
Mortgages are still pretty affordable. According to HSH Associates, at the beginning of November the national average rate on a 30-year fixed-rate loan was 6.4%. FHA loans had a 6.7% rate; the expanded jumbo rate was 6.8%, and the traditional jumbo rate was 7.9%. Adjustable-rate mortgages didn't offer much of an advantage: The interest rate on a 5/1 ARM was 6.4%, and on a one-year ARM it was 5.8% (although one-year ARMs have become scarce). The election may help stabilize the market, says Gumbinger, but he sees nothing to suggest that rates will go down anytime soon.
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Home Equity: Lower Limits
A few years ago, home values were rising so rapidly that you could build a pile of equity practically before the ink was dry on your settlement papers -- and then borrow against it to pay for everything from home repairs to college tuition. But lenders have tightened their criteria for approving home-equity loans (in which you borrow a lump sum at a fixed interest rate) as well as home-equity lines of credit, or HELOCs, which are variable-rate deals that let you borrow money as you need it.
For instance, gone are the days when you could max out the appraised value of your house, minus the mortgage. Now you'll be able to borrow no more than 80% of the appraised value, less the mortgage, says Joe Belew, president of the Consumer Bankers Association. "Historically, 80% was run-of-the-mill. When the market got really hot, people were lending 100%. It's now back to historical norms." In areas where prices have plummeted, such as parts of Florida, Nevada and California, the loan-to-value ratio goes as low as 60%.
Lenders are also no longer relying on "drive-by" appraisals, which amount to little more than curbside inspections. Rich Novak, of USAA Federal Savings Bank, says his company starts with an automated valuation model -- which sets values according to location -- and conducts full appraisals "when conditions warrant."
You'll need a credit score of 680 to 720, as opposed to the 650 to 680 you could get away with a few years ago. And as with first mortgages, you'll have to document income and assets. Interest rates depend on the amount you borrow and your location. Recent rates averaged about 5% on HELOCs and 8.3% on home-equity loans, according to Bankrate.com.
Car Loans: Still Available
Despite the auto industry's troubles -- from the worst sales in 15 years to a cash crunch that has led to cutbacks in leasing deals -- there is money to lend. "Credit is available for consumers with good credit histories," says Paul Taylor, chief economist for the National Automobile Dealers Association. If your FICO score is above 700, you shouldn't have trouble getting a loan. If you're below that mark, you may have to shop around more.
No-money-down deals and loans that finance the remaining balance on your old car loan are disappearing, so be prepared to bring some money to the table. If you have a good credit score, a larger down payment "puts you in the driver's seat as far as the rate," says Mark Calisi, of Eagle Auto Mall, in Riverhead, N.Y. If your score isn't so healthy, you may need a bigger equity stake in the car to get a loan. Power Information Network reports that down payments on nonluxury purchases averaged $5,625 in early November, up 14% from the first seven months of 2008. As a percentage of the cost of the vehicle, average down payments jumped from 17.5% to 19%.
"We're seeing banks be more responsible than they were a year ago," notes Michael Morais, of Open Road Auto Group, in Morristown, N.J. Honda Finance, for example, is calling references and verifying employment, which it didn't always do before. As a result, the process takes longer -- up to a few days for subprime borrowers. If your credit isn't sparkling, some lenders may require you to take a loan for 36 months or 48 months instead of 60 or 72, which means higher payments.
Where to shop. Manufacturers and their captive finance companies are eager to dispel the "no credit" rumors. They're aggressively promoting low-rate financing and rebates. Toyota and Nissan recently offered 0% financing on a broad swath of their 2009 models, including the best-selling Toyota Camry sedan and Nissan Rogue crossover. Ford recently offered 0% financing on the Focus and the Fusion. The 0% offers tend to be for short-term loans (typically three years) and go to customers with credit scores above 650. Customers with the same good credit who want a longer-term loan may pay 1.9% to 7.9%. If you have a black mark on your credit record, expect to pay a substantially higher rate. One recent Hyundai Accent buyer got stuck with an 18% rate, even after putting 20% down.
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Foreign carmakers, such as Toyota, are more likely than domestic com-panies to finance customers with shaky credit; some are offering loans to borrowers with scores as low as 550. But if you can't finance through a captive lender, it doesn't mean you can't buy the brand. Through General Motors' Financing That Fits program, GM dealers submit one loan application for you, and hundreds of banks compete for your business.
Even if you think you might get the best deal through a dealer, check in advance with your bank or credit union. Average rates for five-year new-car loans range from 6.4% with credit unions to 6.6% with banks.
Student Loans: Squeezed
Last spring, the credit squeeze threatened lenders' ability to finance the federal student loans known as Staffords, raising fears that students would be unable to get these loans in time for the fall semester. Congress came to the rescue with the Ensuring Continued Access to Student Loans Act, which allows the government to buy back the loans, if necessary, to keep the loan program going.
As a result, most students have had no problem getting Staffords, which are available to all who apply, regardless of credit history, and carry a fixed rate of 6.8% or less. The new law also increased the maximum amount students can borrow to $5,500 for freshmen, $6,500 for sophomores, and $7,500 a year for juniors and seniors.
Parents with bad credit, however, could have trouble qualifying for a PLUS loan, the parental equivalent of the Stafford. With PLUS loans, which carry a fixed rate of 8.5% or less, you can borrow up to the cost of attendance, but you have to pass a basic credit test to qualify. A foreclosure, bankruptcy or serious delinquency on your bills puts you out of the running.
The Continued Access act tried to give struggling parents a break by extending the period during which lenders may ignore late mortgage or medical payments to 180 days. So far, the provision, which is optional, has failed to persuade lenders to lighten up, says Mark Kantrowitz, of FinAid.org. But students whose parents don't qualify for PLUS loans will qualify for higher maximums on unsubsidized Staffords, for a total max of $9,500 a year as freshmen and sophomores and $12,500 a year as juniors and seniors.
As for private student loans, says Kantrowitz, "Last year, you could get a private student loan if you had a FICO score as low as 620. This year, lenders universally require borrowers to score at least 650, and often 680 to 700 or higher." Borrowers with little or no credit history will need a co-signer who meets those standards to qualify for the loan.
Credit Cards: Higher Scores
Banks are feeling the pinch in their credit-card portfolios, where they are writing off record levels of debt that financially stressed consumers have chosen to ignore. So they've raised required credit scores and lowered credit limits. "In the past few months, we have seen a decline in approvals of credit-card applications and a decrease in credit limits," says Bill Hardekopf, of LowCards.com. "This is a creditor's way of pulling up the drawbridge to protect itself from potential defaults."
A year ago, a credit score of 720 had lenders lining up for your business. Now, a customer with a credit score of 740 or 750 would get approved for a credit card but might not qualify for the lowest rate, says Hardekopf. You're less likely to receive solicitations for new credit. And don't expect as many offers to roll over debt to a card with an introductory teaser rate, says Gregory Larkin, senior banking analyst at Innovest.
For existing customers, some lenders, including Citi, are raising minimum score requirements for cash advances. Automatic increases in your credit line are rarer, too. Plus, lenders are less willing to cut you slack for minor, one-time infractions. Some lenders, including Capital One, have increased their focus on collections.
In some cases, credit-card companies are even using geography as a risk factor. That's especially true if you live in an area that's experienced declining home prices or if you hold a subprime mortgage.
What to do. Pay on time, even if it's just the minimum. You could receive a reminder -- and a spike in your interest rate -- if your payment arrives one day after the due date. If your card issuer lowers your credit limit, you may receive a separate notice or see it announced in your monthly statement. Ignore the change and you run the risk of exceeding your credit limit, which triggers a fee and possibly an increase in your interest rate.
Hold your balance to below 30% of your credit limit. If your spending creeps above that ratio, it's a red flag that lowers your credit score and could prompt your issuer to raise your interest rate.
If you have a card that you keep for emergencies, take it out every few months and use it to avoid having it canceled by the issuer due to inactivity. It's best not to close accounts because doing so increases the ratio of your outstanding balance to your available credit, which can hurt your credit score.
This article was written by Jessica L. Anderson, Jane Bennett Clark, Patricia Mertz Esswein, mary Beth Franklin and Joan Goldwasser.
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