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Enterprising Rural Families

Chat This Month An Online Newsletter September, 2005 Volume 1, Issue 9
Reminder: The chat this month Consumer Debt: Understanding Your Credit Reports
is scheduled for North America: (Part One)
Pacific Time- 6 p.m., Mountain Many Americans are spending more than they earn and according to Cam-
Time- 7 p.m.; Queensland, Aus- bridge Consumer Credit Index, for the first time in history more people (28 percent)
tralia: Eastern Time-12 Noon. made a New Year’s resolution in 2004 not to lose
The topic is “Understanding weight or exercise more, but to reduce their debt
Credit Reports” (Laurier, 2004). Most, if not all, individuals are
faced with the overwhelming challenge of reducing
and/or eliminating their debt burden. Accumulated
debt may stem from poverty , unemployment, un-
Suggested Progress by deremployment or reduced wages, divorce, medical
Group: In order to stay current, expenses, frivolous spending, being a victim of iden-
by the end of this month you tity theft or an unexpected expense. As a result,
should be completed to: consumer debt can lead to negative economic conse-
quences; such as loss of a home, not being able to
Antarctic – provide basic needs, having utilities shut off, not
being able to find a job, may cause stress related
illnesses, or worse, bankruptcy. Furthermore, debt
Arctic – also can have negative effects on consumers’ overall
well-being.
Atlantic – Increased consumer purchasing power has
been made more easily available by the credit in-
dustry; individuals and families alike are one pay- ...Credit constraints should play a role in
Baltic – End of Module 7 check away from the brink of financial ruin. People
keeping household debt down.

are now paying for things such as groceries, tuition

Bering – 2nd Week of bills, fast food, movies, rent, medical care, prescriptions, gas, and home repairs with
“Project” in Module 6 their credit cards. Moreover, if fixed expenses are high, food and other categories of
variable living expenses must fall to compensate. But do they, or do consumers, con-
tinue to compensate via more credit? Ultimately, credit constraints should play a
Black – End of Module 5 role in keeping household debt down.

Consumer Debt Studies

Caribbean - 2nd Week of
Consumer financial debt levels and soaring bankruptcies have encouraged
Module 4 many researchers and organizations to study the magnitude and effects of debt both
on individual and household levels, looking at consumption and investment pat-
Coral – End of Module 2 terns. Many organizations such as Demos, Argus Research, MyVesta, CardWeb,
Economic Research Service, AARP, U.S. Department of Agriculture, U.S. Depart-
ment of Health and Human Services, CNNMoney, and CBS News all have their own
Indian – End of Module 1 surveys and studies regarding consumer debt.
Most studies, though, have only focused on consumer (personal) debt in
Mediterranean - terms of credit cards and mortgages. However, personal debt also may include medi-
cal expenses, school loans, insurance (car, life, etc.), alimony and back child support,
car loans, personal loans, legal bills, old utility bills, unpaid property/income taxes
Pacific - and other bank lines of credit. Other causes contributing to greater household ex-
penditure ultimately leading to increased debt that are not as obvious are gambling
Red - debt, daycare costs, drug addictions or recurring payments such as gym member-
ships (billed on a regular basis). All the sources of debt, consumers are willing to
incur, has led to a rapid increase in outstanding consumer credit .
Contact e-mail for further course
Determining Creditworthiness
information:
Years ago it would have been impossible to walk into a credit institution
[email protected] and apply for credit without first having an established credit history or having col-
lateral to back up the loan request. However, over the past few years it has been
 PAGE 2 E NTERP R IS I NG R UR A L F AMI LI ES TM V OLU ME 1 , I SSUE 9

Continued from page one – Consumer Debt: Understanding Your Credit Reports

been easier to obtain credit with the interest rates set at historic lows and the lax borrowing requirements, such as a low
or no down payment, extended maturities, and credit approval for the riskiest consumers. Consequently, with the aver-
age debt load per household estimated at $18,700 in 2003 – this figure only represents credit card debt and car loan debt
- (Laurier, 2004), lenders are now looking at several factors to determine a person’s creditworthiness before extending
credit. Once a person has established credit, their credit history may be recorded with the three different credit bureau
institutions; Experian, TransUnion and Equifax, which is just one factor credit institutions will contemplate when decid-
ing to extend credit.

Annual Free Credit Reports

It is important for an individual to look over his credit reports at least once a year, because any flaw can seri-
ously damage a person’s credit rating. For instance, information may have been mistakenly reported or someone may
have stolen a person’s identity and opened accounts under their name; both of which can have serious consequences. Eli-
gibility for an annual free credit report is determined by the state of residence based on the rollout schedule set by fed-
eral law, as follows: Western States – December 1, 2004; Midwestern States – March 1, 2005; Southern States – June 1,
2005; and Eastern States and all U.S. Territories – September 1, 2005. This was made possible by the new federal law,
known as the Fair and Accurate Credit Transactions Act (FACTA), adopted by Congress last year. Before this act a per-
son had to purchase their credit reports from each of the credit bureaus (some states like Colorado offered their residents
free credit reports annually).
Consumers may obtain their free annual credit report via the website at www.annualcreditreport.com, by calling
the toll-free telephone number 877-322-8228, or by completing the Annual Credit Report Request Form found at
www.ftc.gov/credit and mailing it to Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.
Since this is a central website for all three credit bureaus do not contact each one individually. Furthermore, reports may
be ordered at the same time or a consumer can order just one or two.

FICO Score Based on Five Types of Data

There are two things to look for in a credit report: 1) the overall validity of it and 2) the FICO score. However,
the old saying “nothing is ever free” is fitting; even though the credit report is free, a person is still charged a fee to ob-
tain their FICO score which is what all lenders consider before deciding to extend credit. The FICO score was developed
by Fair Isaac & Company and is a general person’s credit rating that is calculated using a mathematical calculation from
the five types of data obtained in a credit report as figure 2 illustrates.

Figure 2: The Importance of Five Different Types of Data Reported

in Credit Reports to Determine FICO Score

Payment
History Amounts
Owed
35% 30%

10% 15%
10%
Types of Length of
Credit Credit
Used New Credit History

Source: MyFico; January, 2005

FICO scores usually range from 500-850 (can go as low as 150 and as high as 950), the higher the FICO score the
lower the interest rate and thus payments. Take for example, a $150,000, 30 year fixed-rate mortgage; Table 1 compares
the FICO score, interest rate for a particular FICO score and the average monthly payment. Over the life of the loan an
individual with the lowest FICO score will have monthly payments of $363 higher than an individual with the highest
FICO score. More notably, that same individual will pay a whopping $130,680 more (FICO score 720-850 = $315,000 and
FICO score 500-559 = $445,680) for the same loan scenario! Furthermore, a FICO score of 620 or less is categorized in
the riskiest category, known as subprime, in which a person will incur the highest borrowing rates.
 V OLU ME 1 , I SSUE 9 E NTERP R IS I NG R UR A L F AMI LI ES TM PAGE 3

Table 1: Comparisons of a $150,000 30 year, fixed-rate mortgage (Source: MyFico; January, 2005)
FICO Score Interest Rate Monthly Payment
720-850 5.75% $875

700-719 5.87% $887

675-699 6.41% $939

620-674 7.56% $1,055

560-619 8.53% $1,157

500-599 9.29% $1,238

Overall, FICO scores determine how risky an individual will be in repaying a credit obligation. Obtaining FICO
scores to determine creditworthiness is not just limited to the mortgage industry; they apply to all aspects of the credit in-
dustry. For instance, credit card companies look at FICO scores to determine how high to set interest rates; the same is
true when applying for a car loan or personal loan. Furthermore, employers are now pulling credit reports to help deter-
mine a person’s character. In addition, insurance companies also are obtaining FICO scores to determine rates on their
policies. One can assume, then, that a person’s FICO score is probably the most vital statistic to Americans.

The Three C’s of Credit and the Debt-to-Income Ratio

In addition to obtaining FICO scores there are two other factors credit institutions may use to help determine a
person’s creditworthiness; the three C’s of credit and the debt-to-income ratio (DTI). The three C’s of credit are: capacity –
the ability to repay; collateral – what forms of assets and if any late payments have been made; and character – what is the
length of stay at current and past jobs (Killian, 2005).
Financial institutions will also look at a person’s DTI; another key indicator of an individual’s financial picture. A
DTI of 10 percent or less is considered great; this however does not include mortgage/rent, utilities, etc. When including
mortgages and all other loans/debt (revolving unsecured debt) obligations, a DTI should not exceed 36 percent of gross
monthly income. If a person’s debt does exceed 36 percent, just one financial strain such as a medical emergency, an unex-
pected illness, or divorce could topple the consumer.
A person’s FICO score, the three C’s of credit and the DTI all illustrate to credit institutions and individuals the
consequences that having no debt, some debt or too much debt can affect every aspect of a person’s life.
For more information on personal finance and the management of rural family enterprises, check the Enterprising
Rural Families website at: http://eRuralFamilies.org.

This topic will be continued in the next newsletter in which the complexities of reading your
credit report and understanding your credit scores will be addressed.

Author: Gail Gordon, Business Development/ Family Econ, University of Wyoming

References
Federal Reserve Board. < http://www.federalreserve.gov/releases/> (2005).
Killian, M.T. “Keys to Establishing and Then Maintaining a Good Credit
File.” <http://credit.about.com/cs/creditrepair/a/060403_p.htm> (13 January
2005).
Laurier, J. “US Consumer Debt Reaches Record Levels.” (2004). <http://
www.wsws.org/articles/jan2004/debt-j15/shtml> (19 January 2005).
MyFico. “What’s in Your Score.” MyFico – A Division of FairIsaac.
<http://www.myfico.com/myFICO/CreditCentral/ScoreConsiders.asp?fire=5>
(10 January 2005).
Desiree Olson, Assistant Research Scientist, University of Wyoming Depart-
ment of Agriculture and Applied Economics, March 23, 2005.

Enterprising Rural FamiliesTM

September, 2005 Volume 1, Issue 9 All the sources of debt, consumers are willing to
incur, has led to a rapid increase in
outstanding consumer credit .