Restoring Good Credit a First Step to Personal Economic Recovery

In the wake of the Great Recession, more Americans are turning their focus to personal financial recovery. Whether they are recovering from a setback such as unemployment or reduced income, increasing their rainy-day funds, shoring up retirement savings, reducing high-cost debt balances, or all of the above, consumers know that good credit is key to financial stability and success.

Effective Jan. 1, 2011, consumers have more access than ever to credit reports and scores due to new federal credit disclosure rules. The rules implement the risk-based pricing provisions of the Fair and Accurate Credit Transactions Act of 2003. Creditors are now required to provide a risk-based pricing notice to individual applicants when the creditor uses a consumer report to offer credit terms that are less favorable than the terms offered to a substantial portion of that creditor's customers. This notice explains why applicants with lower credit scores (more risk), may be offered higher rates than those with higher credit scores. In lieu of a risk-based pricing notice, creditors may provide a notice to all applicants that includes the consumer's credit score, an explanation of how the creditor uses this information, and instructions for obtaining a free credit report. Creditors must provide the disclosure before the consumer accepts the offer.

The notice requirement is designed to alert consumers about negative credit information on their consumer report(s) so they can check their reports and correct inaccuracies. To help consumers understand the new credit decision notices, the Federal Reserve has published an online guide, What You Need to Know: New Rules about Credit Decisions and Notices.

Although Texas has weathered the recession better than many states, its credit scores continue to remain well below average. Texas consumers have historically had some of the worst credit scores in the country. National credit reporting company Experian monitors several components of consumer credit behavior and publishes a National Score Index.

Components of the index include:

Average credit scores
Debt levels
Credit usage
Late payments
Credit inquiries

Texas has an index of 670, compared with the U.S. index of 692. Only Nevada is lower at 668. Louisiana and New Mexico—part of the Federal Reserve's Eleventh District along with Texas—have only slightly higher indexes of 674 and 677, respectively.

Nonprofit credit counseling agency CredAbility, formerly known as Consumer Credit Counseling Services of Atlanta, calculates a Consumer Distress Index (CDI) that provides a quarterly measure of the financial condition of the average American consumer. A CDI below 70 is labeled "distressed or unstable." Using data on credit, employment, household budget, housing, income and net worth, CredAbility gives Texas a CDI of 66.5 for third quarter 2010. This is slightly improved over the state's two-year low CDI of 65.4 in fourth quarter 2009 but a large decline from its precrisis high of 76.4 at the beginning of 2006. The national CDI is 64.4. Michigan at 58.1 and Mississippi at 58.8 have the lowest indexes, and North Dakota at 79.9 and South Dakota at 76 have the highest.

Consumer Credit Counseling Services of Greater Dallas (CCCS) recently hosted a Financial Education Town Hall Meeting to explore the low Texas credit scores and consider possible solutions. Speakers included Todd Mark, CCCS vice president of education; Elisabeth Leamy, broadcast journalist for Good Morning America and author of personal finance book Save Big; Alfreda Norman, assistant vice president and Community Development officer at the Federal Reserve Bank of Dallas; and Pamela Yip, business columnist for the Dallas Morning News.

The Dallas Morning News partners with the local Financial Planning Association to offer a unique service to readers. The newspaper forwards questions regarding personal finance from readers to certified financial planners. According to Yip, the overriding theme of readers' e-mails and letters the past couple of years has been "getting out of debt." Yip, who recently wrote a column on rebuilding credit after foreclosure, strongly advises consumers to act quickly and contact their creditors as soon as they begin to have trouble.

On the topic of paying off debt, Leamy voiced concerns about consumers who overlook the big picture. "My pet peeve is people who have a savings account and also credit card debt. That's like trying to fill a bathtub with the drain open. They should be using those low-interest savings to pay off the high-interest debt. It's basic math." Norman suggested that consumers start with the basics: a balance sheet with assets, liabilities and net worth that also shows where a consumer's funds are leaking on high-rate debts. With those debts paid off, the consumer can then make a bigger impact on increasing savings and net worth.

Norman added that many free tools are available for consumers to increase their knowledge about personal financial management, with step-by-step guidelines for budgeting and saving, and managing credit and debt. "Knowledge is power, but knowledge plus action is real power," she said. One free resource is the Dallas Fed publication Building Wealth, which can be ordered from the Bank's website. Copies are available in print in English and Spanish and on interactive CD-ROM for PC or Mac. A Spanish-language interactive version may also be accessed on the website. Other components are available, including an instructor's manual and high school lesson plans.

Mark commented that Texans can't blame low credit scores on unemployment. Income and education levels are sources of difficulty for many. "What we've learned in this region is we really need financial education to help consumers live within their means, to teach them to only take on obligations they can honor and how to use credit responsibly. Our approach at CCCS is taking our clients from Crisis to Control to Confidence to Success."

Mark said Experian's National Score Index shows that Texans have the second-highest utilization ratio in the nation. "Whatever credit we do have, we use it. Or maybe we're more dependent on it."

Mark suggests that it's in the creditor's best interest to make sure that customers have access to trusted resources to help them set short- and long-term goals. If someone is struggling with credit accounts, often the last place they will turn is to the creditors. CCCS and similar nonprofit organizations throughout the Eleventh District partner with financial institutions and employers to provide credit-building expertise to the community.

The Federal Reserve Board has helpful consumer information about credit reports and scores. The Board's five tips on improving your credit score are also useful:

Get copies of your credit report—then make sure information is correct.
Pay your bills on time.
Understand how your credit score is determined.
Learn the legal steps to take to improve your credit report.
Beware of credit repair scams.

e-Perspectives, Volume 11, Issue 1, 2011

Federal Reserve Bank of Dallas Community Development Office P.O. Box 655906, Dallas, Texas 75265-5906 214-922-5377
Alfreda B. Norman Assistant Vice President and Community Development Officer		Julie Gunter Senior Community Development Advisor
Jackie Hoyer Houston Branch Senior Community Development Advisor		Wenhua Di Community Development Economist
Elizabeth Sobel Blum Community Development Research Associate		Roy Lopez Community Development Specialist
The views expressed are the authors' and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System. Articles may be reprinted on the condition that the source is credited and a copy is provided to the Community Development Office.

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Restoring Good Credit a First Step to Personal Economic Recovery

e-Perspectives, Volume 11, Issue 1, 2011