Did your credit score increase this year? It did for the average American. What does this mean for consumers and for the economy? We’ll tell you our thoughts on this below.
Americans are getting better at managing their credit.
At least that’s what a new report from FICO would indicate, as the average FICO score for Americans has reached 704, a 4 point increase from last year.
That’s an all-time high.
But why did this happen, and what does it mean for consumers? What does it mean for the economy?
I’ll explore all of that in this article, as well as provide you tips and tricks for increasing your credit score right away.
Possible Reasons for the FICO Score Increase
There are a number of reasons why the average FICO score has increased so significantly. Here are a few:
People know more about their credit and how to raise their score
According to Ethan Dornhelm, FICO Vice President of Scores and Predictive Analytics, people know more about their credit and how to raise their scores than they did in the past. In fact, myFICO has an entire blog dedicated to teaching people more about their credit.
For example, did you know that your FICO score can affect your ability to get an FHA loan? Author Rob Kaufman outlines the details in this article and tells us facts like you need at least a 580 credit score to qualify for the desirable 3.5% down payment.
I found that information within minutes of beginning research for this article. That’s just an example of the type of information about credit that has become easily accessible and right at our fingertips.
Lenders are being more cautious
Because of the recession years ago, lenders have become more cautious when loaning money to consumers. Recent data gathered by LendingTree shows us that in the 10 years that have passed since the start of the Great Recession, lenders have become increasingly more cautious–specifically with home loans. The article states that “although there are some issues with an adequate housing supply, in general, mortgage lenders are relatively strict about to whom they will lend, and for what amounts.”
Just a year ago, Kevin Graham of Quicken Loans wrote about how it’s more difficult for millennials to buy a home than it was in the past. This is partially due to the increased credit guidelines for lending.
This increase in strictness from lenders raises the barrier to enter into the mortgage market, filtering out less responsible borrowers. In turn, this will cause borrowers who don’t qualify to buckle down and increase their credit scores–thus impacting the overall rise in average scores across the country.
A new policy removed civil judgments
Earlier this year, the three major credit reporting agencies–TransUnion, Equifax, and Experian–said that approximately 50% of all tax liens and almost all civil judgments were removed from consumers’ credit reports. According to CNBC, “the new rules come following a study by the Consumer Financial Protection Bureau that found problems with credit reporting and recommended changes to help consumers.”
This was a huge win for consumers– many who saw a change in their credit score anywhere from 10 to 30 points. While not everyone saw a big impact, Zack Friedman of Forbes noted that consumers with weaker credit could experience a higher impact.
People are becoming more responsible with their credit
The American Bankers Association defines a delinquency as a late payment that is 30 days or more past due. The 15-year average for this rate is 2.14% on installment loans and 3.56% on credit cards.
While both rates saw a slight uptick in the first quarter of the year, both rates are still well below their 15-year averages. According to the ABA, the end of the first quarter of 2018 showed a 1.73% delinquency rate for installment loans and a 3.06% delinquency rate for credit cards.
James Chessen, the ABA’s Chief Economist was quoted as saying that “bank card delinquencies have been near historical lows for five years as consumers have done a great job managing their levels of debt,” and that “the ratio of credit card debt to disposable income remains low and is nowhere near pre-crisis levels.”
People are repaying their debt
This is kind of a good news/bad news situation, depending on how you look at it. In April of this year, New York Post reported that Americans owed more than $930 billion in credit card debt. That’s a LOT of debt.
However, a study done by WalletHub showed that Americans paid off nearly $41 billion of that in the first quarter of 2018. This was the second largest amount paid off in a quarter by Americans–ever. That’s the good news. The bad news is that we proceeded to add about $30 billion back to the overall debt in the second quarter, which still puts us at a net reduction for the year so far.
While this number will always fluctuate, the fact that we’re focusing on paying off our debts is a good thing. And the fact that we added more debt in the second quarter can mean a number of things. For example, when you think about the points I made above, we may be becoming more responsible with our credit and able to manage that debt better down the road.
We have fewer collections
A collection account can pop up on your credit report at any time and for any reason. When it’s a true collection, it means you haven’t paid something that you owe and the creditor has hired a collection agency to get as much back as they can. In most cases, lenders will sell off the debt to collection agencies, but I digress. The good news is, only 23% of Americans had collection accounts on their credit reports in 2018–down 5% over the past three years.
Low scores are down and high scores are up
According to the Chicago Tribune, FICO scores ranging from 300 to 499 are down over 3% in the past 9 years, while scores ranging from 500 to 549 are down nearly 2% over the same time period. In addition, the percentage of consumers with scores under 650 dropped over 6% since 2009. This may not seem like a lot, but when you consider that 2% of the American population is over 6 million people, it’s a big deal. On the other side of the coin, Americans with high-end scores have increased. Currently, more than 1 in every 5 Americans has a credit score over 800, while 42% have a score between 750 and 800.
What Does this Mean for Consumers?
The change to the average FICO score does impact consumers, particularly in the way they behave with spending, saving, and borrowing.
They’ll save money with better rates
As credit scores increase, available rates begin to decrease. It’s simple, really–the better your credit score, the better rate you’ll get on loan products such as credit cards and home loans. This, in turn, will allow consumers to save even more money.
Here’s a great example. As of this writing, the average APR for a 30-year fixed rate mortgage loan is 4.876%. Let’s say that is for the best credit scores. We’ll assume you have a lower credit score of 675 and you get a rate of .5% higher–so 5.376%.
The difference in what you’ll pay over the course of 30 years is shocking. On a $300,000 loan at 5.376%, you’ll pay $304,836 in interest (yikes!). By simply having a better credit score and getting a .5% lower rate (4.876), you’d pay only $271,610 in interest–a difference of over $33,000. Now, we’re looking at HUGE dollar amounts that you’ll pay in interest–so in the grand scheme of things you may not think $33,000 is that big of a difference, but for some people, that’s an entire year’s salary. It pays to have a better credit score–as you can see, you’ll save money in the long run.
They’ll spend more
When lower rates become available with better credit scores, consumer spending habits tend to change. As I stated above, lower rates will entice consumers to wait and take on lower rates as they become available, saving them money. But where does this “extra money” go? In many cases–spending.
There is a Keynesian economic theory called Marginal Propensity to Consume (or MPC), which basically states that as our income increases, so does our spending (our “propensity to consume”). For example, if you get a $1,000 bonus, you now have an extra $1,000 you didn’t have before. You can choose to spend that money or save that money. The money you spend is your marginal propensity to spend, while the rest is your marginal propensity to save. So if you bought a $400 espresso machine (yeah – that’s a real thing people buy now), your marginal propensity to spend is .4 (400/1000), while your marginal propensity to save is .6 (the remainder; 600/1000).
Nerdy economics aside, the theory is often correct in that we tend to spend more when we have more to spend, or when lower rates become available. As J.B. Maverick of Investopedia states, “if rates are already at very low levels, however, consumers will usually be influenced to spend more to take advantage of good financing terms.”
What Does this Tell Us About the Economy?
Consumers are impacted, but so is the economy. While the FICO score increase didn’t necessarily change these factors, it’s yet another sign that we’re headed in the right direction. Here are some of the economic impacts we’ve already seen:
Consumer confidence is up
Consumer confidence is a catch-all metric that measures how consumers feel about the economy–both current and future state. The indicator used can help predict things like future spending patterns in the economy (more on this below).
Consumer confidence just hit an 18-year high this month. Harriet Torry of the Wall Street Journal says that this is “a positive indicator for spending going into the holiday shopping season, as robust job growth and a strong economic outlook bolstered Americans’ expectations for the future.”
Unemployment is down
In addition to consumer confidence going up, the unemployment rate is decreasing. While youth unemployment hit a 52-year low, overall unemployment reached a tie for the lowest unemployment rate since 1969. As this rate declines, more consumers are employed, which directly impacts the economy. When more workers are employed, their families gain wages. This, in turn, increases the number of goods and services produced, which increases the number of goods and services consumed as purchasing power increases, causing somewhat of an economic ripple effect, leading to my next point.
Shopping will hit record highs this year
These factors are expected to increase household spending this year rather significantly. Household spending accounts for about 70% of the U.S. economy. Per Deloitte’s annual retail sales forecast for the holiday season, retail sales are expected to grow between 5 and 5.6% from a year ago, saying that holiday retail sales could top $1.10 trillion this year.
What Credit Score Should Consumers Aim to Have?
Consumers should aim to have a credit score of at least 700. Credit reporting agency Experian backs this up by saying “for a score with a range between 300-850, a credit score of 700 or above is generally considered good.” A score of 800+ is considered excellent, while most credit scores range from 600 to 750.
Tips on Increasing Your Credit Score
There are many ways you can go about increasing (and maintaining) your credit score. First, here are five tips that the Consumer Financial Protection Bureau (CFPB), a government agency, gives on getting and keeping a good credit score:
- Pay your loans on time, every time – your payment history accounts for 35% of your FICO score, so making sure that you’re paying on time is critical.
- Don’t get too close to your credit limit – credit utilization rate is another factor that impacts your credit score so be sure to not use too much of your available credit.
- A long credit history will help your score – your length of credit history will impact your score, so the longer average credit history you have, the better.
- Only apply for the credit that you need – hard pulls on your credit will hurt your score, so you should only apply for credit that you actually need and will use immediately.
- Fact-check your credit reports – mistakes happen, but so do errors on your credit report, so you should always check your credit to make sure everything is in order and there are no negative marks on your credit report that shouldn’t be.
Furthermore, we at Dough Roller have put together several guides on this topic for you go to even deeper with:
- How to Build Credit When You Are Just Starting Out (the Smart Way)
- Credit Reports vs. Credit Scores: Do You Know the Difference?
- 11 Simple Ways to Improve Your Credit Score Today
You can also check out our archives on credit to read even more articles on this topic.
How Often Should You Check You Credit Score?
Consumers should check their credit reports at least once a year, but an even better strategy is to space them out three times year. Since you’re entitled to one free credit report from each of the three major credit reporting agencies (Equifax, Experian, and TransUnion) each year, a sound strategy is to pull one of them every four months. That way you’re keeping regular tabs on your credit.
Remember, though, that by doing this you’ll simply get a copy of your credit report–which won’t contain any additional information, such as your credit score or tips for improving your credit. A better option might be getting a free copy of your credit report from places like myFICO, Credit Karma, or Credit Sesame. Each of these vendors offer unique perks that help you monitor and improve your credit quicker and more efficiently.
The average credit score increasing to 704 has a lot of downstream impacts, as you can see. But it also indicates a sign of bigger economic improvements. If you haven’t reached the 704 mark yet, don’t worry. Buckle down and use the tips I referenced above to get your credit score up, then you can start taking advantage of better rates and saving more money on your borrowing needs.Topics: Credit