When the limits on two of Bill Johnson's credit cards were lowered from $20,000 to $6,000, his outstanding balances jumped from a perfectly acceptable 20% to a dangerously high 66%.
It wasn't Johnson's fault that the card issuers lowered his limits. They were just following the requirements under the CARD Act of 2009, legislation designed to establish fair and transparent credit practices.
You might say he was the "beneficiary" of a law intended to help him — as long as you kept your tongue planted firmly in your cheek.
Through no fault of his own, lenders now look at Johnson's credit file and see a would-be borrower who no longer qualifies for the lowest possible mortgage rate. Now he's in the subprime category, and to a lot of lenders these days, subprime borrowers are verboten.
Nearly a decade after the mortgage market meltdown — which was caused, in part, by overzealous lending to unqualified homebuyers with less-than-pristine credit — subprime borrowers remain forbidden fruit, fit only for government-backed loans, if that. For the most part, lenders who only offer conventional loans won't touch them.
Tim Ranney says that sometimes, lenders are smart not to do business with clients whose credit scores are below 650. But, he is quick to point out, many of those with scores below that magic number are acceptable credit risks, as long as they are properly underwritten.
And Ranney, who shared the hypothetical example of "Bill Johnson" above, should know. He is president of Clarity Services, one of the new batch of credit-reporting agencies that have cropped in recent years to challenge the supremacy of the three major credit repositories: Equifax, TransUnion and Experian. Or if not to challenge them directly, then at least to add to the documentation on which lenders base their decisions.
Clarity focuses on the "underbanked," near-prime and subprime consumer who have minimal credit records. It has useable credit information on 55 million people that are considered subprime. From a pure data standpoint, adding reports such as the one from Clarity will allow lenders to approve what otherwise would be marginally risky borrowers who previously would have been turned down.
The company also sponsors important research into what Ranney has relabeled the "nonprime" sector. The company backs numerous academic studies, but has no say-so in their findings. Its only requirement is that it is the first to publish the results, which are posted on its website, nonPrime101.com.
Whereas prime-rated borrowers fit into an easily categorized box, nonprime folks are "defined by what they're not," says Aaron Klein, policy director of the Initiatives on Business and Public Policy at the Brookings Institution. "Young people with limited credit experience, single parents with credit issues, college kids and abusive credit defaulters are all lumped into one."
But they're not all the same, according to Klein. He was the lead speaker at a recent nonPrime101 conference in Tampa, Fla., where the latest Clarity-sponsored research was presented. Whereas one in six nonprime borrowers is insolvent and stuck in a downward spiral, the rest are merely "illiquid" — as Klein explains, "They are likely to pay back; they just don't have the cash right now."
The usual driving factor of illiquids, 60% of whom are hourly workers, is an unforeseen income drought. If there is a major snowfall, for example, snowplow drivers make out like bandits. But the cleaning lady who normally works six days a week may not be able to get to her job sites for a few days, and will lose money. Ditto for waitresses and bartenders who can't get to restaurants and bars.
Or when a divorced dad loses his job and can't make his support payments, the kid's mom also feels the pinch. When it rains for a solid week, roofers can't work at all. When a holiday falls on a Friday, your paycheck may not arrive on Saturday in time for you to get to the bank.
These are real-world scenarios of otherwise good people who hit a bump in the road. And the challenge for lenders is how to identify them for what they are, as opposed to serial insolvents, who take larger and larger risks in an attempt to pull a rabbit out of a hat and postpone the eventual day of reckoning.
That's where the new breed of credit bureaus like Clarity, PRBC, VantageScore and others come in. They collect the data the majors don't — things like rent and utilities, which are not reported to the big three credit repositories; monthly unsecured obligations like payday loans, family loans and car title loans, and information that validates that the person's stated income is consistent with what was said on previous loan applications.
"There should be a set of facts everyone can count on," says Ranney. "Even as you go down the credit spectrum, there is a healthy percentage of the population that, within the limits of their ability to repay, are good credit risks. If they take a loan they can afford, they will pay it back.
"Low income is not automatically nonprime, and high income is not automatically prime. There are a significant number of consumers with low credit scores who, for one reason or another, have experienced some kind of financial setback. But they are completely stable, and have enough income to handle a mortgage."
Lew Sichelman is an independent journalist who has been covering the housing and mortgage markets for more than 40 years.