An outside view on debt!
How do people see those that are in debt?
How the Lending Community Views Lending to Consumers with Past Credit Problems
A Changing Community
Many years ago banks would only lend to “good” people, meaning those with no credit problems of any kind. However, as competition has increased among lenders and as lenders learned how to price for the credit risk of the consumer, lenders have begun to lend to debtors of all credit profiles.
Hence, you often see the slogan: “Bad Credit, No Problem!” What is not readily revealed is that lenders who target people with credit problems often offer them extremely highly priced services. These lenders demand exceptionally high, but legal interest rates, and include other costly terms and conditions with every loan they make.
Lenders, Risk Management and Lending to Consumers with Past Credit Problems
A lender will almost always charge more for a financial service that is sold to a consumer with a history of credit problems than to a consumer with no history of credit problems. Once a consumer has incurred prolonged delinquencies and charge offs, he is labelled a "problem debtor" and his credit risk rises in the eyes of the typical lender. As credit risk rises, so do interest rates, fees and other charges. These charges rise because lenders have determined that lending to consumers with past credit problems is more risky and more expensive. These lenders usually encounter increased servicing charges and much higher default rates, all of which must be funded by charges to this consumer.
Lenders who service consumers with past problems have stratified themselves according to the riskiness of the consumers they target. They refer to themselves as “sub prime” lenders, meaning that they are not targeting “prime” borrowers, who are often referred to as “A” credits. “A” credits are consumers with no history of credit problems, even though they are veteran users of credit products and services.
The “sub prime” lenders have categorized themselves as “B,” “C” or “D” credit lenders, with “D” lenders targeting the riskiest debtors in the population. The sub prime lenders judge their credit risk primarily from credit report data and credit application data, with credit report data often taking precedence over income and other assets listed on the application. Many are developing specialized credit scoring algorithms to help them manage the many unique risks inherent in
sub prime lending.
For example, a “D” credit might be a prospect with six charge offs totaling over $16,000, two delinquencies in the last year and a one year old bankruptcy on his credit report. The profile of the “D” credit is one who is still accumulating problems, as noted by the recent delinquencies and has not attempted to fix or cure any past problems, as evidenced by the bankruptcy. Lenders who are willing to accept the risks of lending to a “D” credit charge for that risk with high up front fees, higher down payments, exceptionally higher interest rates, above market late fees and very aggressive collection and repossession terms. The “D” credit lender justifies these charges based upon the riskiness and the costs of servicing the “D” credit market. As long as this lender is within usury laws guidelines, he can continue to offer these services at these rates and the “D” credit borrower has few other alternatives. Let us compare the “D” debtor profile with that of the “B” credit. A “B” credit might be a debtor with two paid charge offs of $4,340, no current delinquencies and no bankruptcy. A paid charge off is a notice that many lenders use to indicate when a consumer has paid off a past charge off. This consumer has clearly curbed his problem and cured past problems. The lender in this segment would offer the “B” credit lower up front fees, a higher chance of acceptance, lower down payments and lower interest and more flexible late fee and repossession terms in whatever financial service they provide. They do this not out of their generosity, but because this lender
has lower costs than the “D” lender and can afford to make this debtor a better offer, in the hopes of getting his business. The “D” credit might find that he must pay 9 - 10 percentage points more for his car loan than the “A” credit and 6 - 7 percentage points higher than the “B” credit. In mortgages, the “D” credit might pay as much as 3- 4 percentage points more in interest rates, should he be able to get one.