In the US life seems to revolve around your credit rating. So whether you want to lease an apartment, get a credit card, get a lease on your car, or get a mortgage on your apartment, you need to have a credit rating.
Now whilst this appears fair to most people, the problem is for people like me who have newly moved here. Credit rating agencies base the credit scores on how you've handled credit in the past. However if you are new to the country, you obviously have no credit. And so, no credit score. And so you can't get any credit. And hence will be unable to get a credit rating. And this Catch 22 situation goes on.
The only way out, is to get what is called a secured credit card, which is nothing but a pre-paid card, that takes a fat fee from you to pretend that its a credit card and report your transactions to the Credit Bureau who will begin to track your credit history and so generate against you the elusive credit score.
In my opinion this whole system of credit rating agencies and credit scores has several flaws. And whilst I personally feel victimized by what I believe to be a completely unfair system, there's a much larger macro issue. And it is this issue that in my opinion was a major contributor for the collapse of the housing market and the global financial recession of 2009 from which the world has yet to recover.
To know whether there's any merit in my conclusion, we need to understand what exactly does a credit report do and how. Whilst you can learn more about it by visiting the sites of the various credit bureaus, a quick summary is that the credit score is an indicator of your current record in handling (repaying) credit and therefore your probability of repaying credit that may be given to you. This therefore is used by lenders to determine whether or not to give you a loan as also the rates they can offer you, based on the perceived risk, which is determined by your credit score.
The method used by credit bureaus to calculate the credit score is reasonably simple. Lenders send them a monthly report on their customers, their credit, their payments, their outstanding as well as their defaults. These numbers are maintained by the credit bureau. To calculate a credit score they use an algorithm that basically sees how much credit you had and how well you repaid them. Hence someone who has been using his credit card for a few years, and has always paid his bill on time, will have a great credit score. And a person who has defaulted or missed a few credit card payments, will have a poor credit score.
https://www.transunion.com/sites/personal-credit/credit-education.page
http://www.cibil.com/about-us
So this sounds like a good idea. It measures a trend of taking credit and repaying. And so should be a pretty accurate measure of the persons tendency to pay back lenders. And therein lies the issue. The above makes 1 basic assumption. The first is that a tendency to pay in the past, implies the tendency to pay in the future. And if this assumption is incorrect, the complete credit rating becomes meaningless. And the fact is that this assumption is grossly incorrect.
There are 2 reasons. The first is that the assumption that a person who repays in the past is likely to repay in the future works only when the individual in question is not aware that his behaviour is being measured. The moment he is aware, his behaviour changes. Knowing that not repaying will affect his ability to get credit. ensures that he repays the credit, when the amounts are small and affordable.
The 2nd issue is that most human beings are at heart good. And would like to repay their debts. This is reflected in their credit history being without blemish. The issue is ability. It does not matter about how good his intentions are. When he just cannot afford to repay, he defaults.
And this is exactly what happened. Lenders were happy to lend based on credit scores. And when the housing market stagnated and then prices started dropping, people who had borrowed on the basis of their property appreciating began defaulting. Starting the collapse.And then aggravating it.
You would think that the above is obvious and so after the bubble burst, changes would be made. Guess what. The only change made is that now lenders want to be more careful. And so they will only lend to those with even higher scores than before. Leaving themselves open to the next collapse.
Now whilst this appears fair to most people, the problem is for people like me who have newly moved here. Credit rating agencies base the credit scores on how you've handled credit in the past. However if you are new to the country, you obviously have no credit. And so, no credit score. And so you can't get any credit. And hence will be unable to get a credit rating. And this Catch 22 situation goes on.
The only way out, is to get what is called a secured credit card, which is nothing but a pre-paid card, that takes a fat fee from you to pretend that its a credit card and report your transactions to the Credit Bureau who will begin to track your credit history and so generate against you the elusive credit score.
In my opinion this whole system of credit rating agencies and credit scores has several flaws. And whilst I personally feel victimized by what I believe to be a completely unfair system, there's a much larger macro issue. And it is this issue that in my opinion was a major contributor for the collapse of the housing market and the global financial recession of 2009 from which the world has yet to recover.
To know whether there's any merit in my conclusion, we need to understand what exactly does a credit report do and how. Whilst you can learn more about it by visiting the sites of the various credit bureaus, a quick summary is that the credit score is an indicator of your current record in handling (repaying) credit and therefore your probability of repaying credit that may be given to you. This therefore is used by lenders to determine whether or not to give you a loan as also the rates they can offer you, based on the perceived risk, which is determined by your credit score.
The method used by credit bureaus to calculate the credit score is reasonably simple. Lenders send them a monthly report on their customers, their credit, their payments, their outstanding as well as their defaults. These numbers are maintained by the credit bureau. To calculate a credit score they use an algorithm that basically sees how much credit you had and how well you repaid them. Hence someone who has been using his credit card for a few years, and has always paid his bill on time, will have a great credit score. And a person who has defaulted or missed a few credit card payments, will have a poor credit score.
https://www.transunion.com/sites/personal-credit/credit-education.page
http://www.cibil.com/about-us
So this sounds like a good idea. It measures a trend of taking credit and repaying. And so should be a pretty accurate measure of the persons tendency to pay back lenders. And therein lies the issue. The above makes 1 basic assumption. The first is that a tendency to pay in the past, implies the tendency to pay in the future. And if this assumption is incorrect, the complete credit rating becomes meaningless. And the fact is that this assumption is grossly incorrect.
There are 2 reasons. The first is that the assumption that a person who repays in the past is likely to repay in the future works only when the individual in question is not aware that his behaviour is being measured. The moment he is aware, his behaviour changes. Knowing that not repaying will affect his ability to get credit. ensures that he repays the credit, when the amounts are small and affordable.
The 2nd issue is that most human beings are at heart good. And would like to repay their debts. This is reflected in their credit history being without blemish. The issue is ability. It does not matter about how good his intentions are. When he just cannot afford to repay, he defaults.
And this is exactly what happened. Lenders were happy to lend based on credit scores. And when the housing market stagnated and then prices started dropping, people who had borrowed on the basis of their property appreciating began defaulting. Starting the collapse.And then aggravating it.
You would think that the above is obvious and so after the bubble burst, changes would be made. Guess what. The only change made is that now lenders want to be more careful. And so they will only lend to those with even higher scores than before. Leaving themselves open to the next collapse.
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