101%
It’s that time of year again. We shower our loved ones with gifts, and send out cards to friends and extended family hoping for a reset for the new year. Most of us don’t have a pile of cash saved for the occasion so we find ourselves taking on new debt to afford it. Sometimes we can do it smartly and consolidate and come out ahead, but most of us are making a deal with the devil. If it seems that your creditworthiness has jumped this time of year, don’t get too excited, it hasn’t. I am sorry for the second off brand article in a row, I promise I will get back to boring computer stuff after this.
The purpose of loans is to benefit both the consumer and the lender in an ideal world. A consumer gets an influx of cash, and the lender gets their money back plus a little extra. The higher your credit score, the less interest you pay. The higher your income, the more you can borrow. The reasons are simple: The higher your score, the more likely you are to repay to completion, and therefore not a risk, so they don’t have to charge higher fees to get their money back quicker before you could potentially default. The higher your income, the more you can afford to pay back. These are all well known and taught economic principles. However, why is it that credit you have unsuccessfully tried for before is now available? The simple reason: They want you to default.
Let us take a thought experiment using a made up personal loan. The borrower has a “fair” credit score and wants $2000 repaid over 24 months, the average interest rate is … lets say 18%. Now assuming said loan is repaid with no hiccups, the bank gets back $2720 from the borrower. Now let’s say a few months later they have to pay a few days late. The late fee is $45, and less of the money goes to the principal, so now its 25 payments which can net them $2900 or thereabouts. For a flat out default, they can only collect on the principal and “reasonable fees”, so in this case if the money just stops coming after 3 months, they can collect on a little over $2000, plus the payments you have already made, they are looking at $2300 or so. If they really can’t wrestle the money out of you, they sell it off to a debt collector at 75% and end up losing money overall, but not very much, or break even. The collection agency gets their 25% cut, and the lender is done with it and moved on, aka charge off.
Obviously option 1 is the safest and also the second most profitable. The most profitable option is for a consumer to have some trouble, but not much paying back the debt. Hence the name of the article 101%. Keeping that in mind, does it really surprise you that you are being offered credit now, when you are known to want it and are unlikely to look over terms and conditions as carefully as you normally would?
I’m really not trying to come off sounding condescending, it is the lenders who are doing that by preying on what they believe is your impulsiveness. Let me explain what got me started on the idea to write this.
In late 2017 I had to declare bankruptcy. A bad divorce left me with a foreclosed house and no retirement account followed by my job of the last 15 years going belly up. I had lots and lots of bad debt on there with no hope of ever repaying, so I took it as an opportunity to make a fresh start. I climbed the credit ladder even occasionally getting involved in crap credit cards, like for example ones with a $300 limit and a $99 annual fee, or one that after a year starts charging you a $12.50 / mo maintenance fee (plus an annual fee on top of it as a yearly surprise). It added to credit though and I used it wisely until it was no longer useful then paid it off and closed them. My car was repossessed as part of the bankruptcy in early 2018. In February of this year (2021) the lender reported a late payment, even though the account had been closed for years. Despite filing a dispute with Experian all they said was the account was legitimate and did nothing. Lo and behold in November, one company offers me a significant amount of revolving credit, and another offers to pay off my car and give me a chunk of money in return for being in a new auto loan with them. Now with years of clean consistent on time payments and being turned down by both entities before, why was I such a hot commodity now?
Then it struck me, the late payment. One late payment semi-recently means you are at your financial ends, but are trying to be responsible, exactly the kind of consumer who will rack up late charges given a little more rope than they can handle. I took them both up on it. The new revolving account now sits at 10% usage with a big increase in available credit and a lower credit usage amount. I used the car place to pay off some of the said crap cards and get rid of some bad debt, so I actually come out ahead on the monthly household balance sheet. Best of all my kids all get a nice Christmas, and I can fund my mad scientist work in the garage for the time being.
Most people are not fortunate enough to have this happen. For most people, they have credit dangling out there in a measure slightly more than they can afford, in hopes that one day soon they can’t make the payment on time. My advice: take them up on it and don’t use it, be option 2, don’t be “profitable”.
