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FICO credit scores range from 300 to 850 points. Banks and other lenders now want to see 700 credit scores and higher, which is all the more reason to strive for perfect credit. You can certainly still obtain credit and loans even if your credit scores fall below 700. But you should know that it’s tougher, and you’re likely to pay higher interest on any loans or credit you do receive if your credit rating isn’t stellar.

Do You Have Good Credit – Or Something Else?

Here is my own completely subjective assessment of your credit, based solely on your FICO score and my personal and professional dealings with bankers and lenders of all kind:

If your FICO score is …          Then your credit is:

760 – 850                                            Perfect

759 – 700                                            Good

699 – 650                                            Average

649 – 620                                            So-So

619 and below                                     Poor

The Credit Crunch Has Led Banks To Demand Higher Credit Scores

Before the credit crunch, for many financial institutions, 620 was somewhat of a magic cutoff number. For example, many banks would require you to have a FICO score of at least 620 in order to get a halfway decent mortgage rate. If your score was less than 620 could you still get the loan? Yes, in most cases. But depending on the severity of your credit problems, you had to pay a lot higher interest rate and more finance charges over the life of the loan. That’s true at every level of the credit spectrum. Those in the “perfect” credit range will pay less than those with “good” credit; those with “good” credit will get better terms than people with “average” credit, and so on. In the current economic climate, having a FICO score in the 600s – even the high 680s – could mean your mortgage application gets denied.

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Consumers scored a big win in 2009, when President Barack Obama signed the Credit CARD Act, which consumer advocates say will stop or prevent unfair or deceptive lending practices by banks and credit card issuers. The law is formally called the Credit Card Accountability, Responsibility and Disclosure Act.

Key Parts of Credit Card Reform

In August 2009, two provisions of the legislation were adopted. The first required your credit card company to give you 45-days notice before an interest rate hike, up from 15 days notice. You have the option to reject a rate hike and close the account. Under this scenario, you would have the right to pay off the debt over five years at your original interest rate. However, there’s one big loophole in this change to the law. The 45-days advanced notice requirement applies only to credit cards with fixed interest rates. Unfortunately, more than 90% of all credit cards issued are variable-rate cards. Additionally, just before the 45-day rule took effect in 2009, many issuers of fixed-rate cards started notifying customers that their cards were being converted to variable-rate cards.

Another change resulting from the Credit CARD Act is that credit card companies must also give you more time to pay your bills, by mailing your bills 21 days before due date; not 14 days, as was previously the case.

Even bigger credit card changes begin February 2010, when a host of other rules take place. For example, the credit card reform law prohibits credit cards from being issued to individuals under 18, and prevents credit cad issuers from retroactively increasing your interest rate, unless you’ve been 60 days or more late paying your credit card bill. Also, effective July 2010, new rules from the Federal Reserve require banks to provide better disclosure to their credit card customers.

Banks React to Credit Card Reform By Tightening Credit and Their Policies

Given all these changes, you may have already noticed changes from your credit card company. Many have began imposing various fees, raising interest rates, slashing credit lines or canceling accounts altogether in an effort to manage risk, offset reduced profits, and generate new revenue streams. According to CreditCards.com, in mid-December 2009, the national average interest rate for “bad credit cards” (i.e. cards issued to those with bad credit) was 13.74%. But rates on various cards can go much higher.

One Bank Is Offering a Credit Card With an 80% Interest Rate

Industry observers say the highest-rate card known in 2009 came from First Premier Bank. It began offering a subprime credit card with a whopping 79.9% interest rate. That card, marketed to people with bad credit, had just a $300 credit limit. In a statement, the company’s CEO Miles Beacom defended the unusually high interest rate, saying it was “based on the risk associated with this market.”

But in response to the onslaught of new fees and other activities by banks, members of Congress considered accelerating the adoption of the new credit card laws, making them effective in December 2009, instead of February and July 2010. While that never happened, lawmakers did continue to debate a bill introduced in December 2009 in the U.S. House of Representatives to cap credit card interest rates at 16%. Currently, banks can charge whatever interest rate they like on credit cards, as long as the information is fully disclosed to consumers. Therefore, First Premier’s 79.9% interest rate card is perfectly legally. The company’s CEO said the bank will “allow the customer to make the decision whether they want the product or not.”

Competition, Regulation and Political Forces Will Ultimately Keep Banks In Check

While the banking industry’s move toward more careful risk management and more scrutiny of credit applicants will be a longer-term trend, I expect that the rise of fees and interest rates, and other punitive actions such as arbitrarily closing accounts, will be a short-term phenomenon. Only time will tell. But I predict that political forces, regulatory oversight and competition factors will all help keep banks in check.

Credit Card Reform Levels the Playing Field

For starters, the outcry of consumer opposition to objectionable bank practices is being heard more clearly now than ever. Additionally, politicians and regulators alike are under pressure to rein in unfair banking activities that unjustly enrich financial institutions at the expense of the public. And finally, sheer economic forces will emerge. Banks will become more competitive in the long-run, and try to stand out by dropping excessive fees and unnecessarily high interest rates for good customers. And when one bank stops imposing annual fees, and that practice starts to win over new business, then the rest of the industry will take note and try to do the same thing. On balance, therefore, credit card reform has created a more level playing field, and can be expected to bring more fairness into credit card lending and marketing practices.

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As of June 2009, the FDIC had about $42 billion in total resources; this includes money in its Deposit Insurance Fund, plus amounts set aside in the agency’s “contingent loss reserves,” funds earmarked for current and future losses. While the FDIC takes pains to tell the public that the agency is in no imminent financial danger and that it will not need to be bailed out by U.S. taxpayers, the agency in November 2009 adopted a new plan requiring all insured banks pre-pay (on Dec. 30, 2009) their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012.

FDIC Says Costs of Covering Failed Banks Is Taking a Toll

These quarterly premiums are the fees that banks pay in order to receive FDIC deposit insurance.  The FDIC asked for these $45 billion worth of early payments from its member institutions because the FDIC said it had under-estimated the cost of taking over failed banks, and needs to immediately replenish its available funds. In 2009, 140 banks collapsed in the U.S. However, some observers saw the FDIC request as a “gimmick” move to help the banking industry because the $45 billion would be treated as an asset on banks’ balance sheets (a prepaid expense, to be exact), and would not diminish banks’ capital or hamper their ability to lend money.

In order for a bank to declare that it is FDIC insured, it must meet certain financial requirements imposed by the FDIC. Specifically, banks must maintain healthy, federally-mandated “capital ratios.” This refers to the amount of capital (or dollars) a bank must have set aside in reserves in order to guard against future, potential losses.

Banks Lend (or Not) Based in Part on Their Ability To Meet FDIC Rules

One key capital ratio for banks is called a “risk-based capital ratio.” It measures the capital a bank has (such as its common stock, preferred stock, and undistributed net income/profits) versus the amount of “risk-weighted” assets that bank has. These risk-weighted assets can be anything from corporate bonds and consumer loans (including mortgages, auto loans and leases, student loans, credit cards and personal lines of credit) to government notes and cash. The former – corporate bonds and consumer loans – all carry a risk rating of 100%, meaning they are highly risky since there’s no guarantee at all that they will be repaid. Meanwhile, government notes and cash are deemed risk-free.

If the notion of a loan being both an “asset” and something that is “risky” seems a little tricky, let me explain it briefly. A loan/credit line is called a “risk-weighted” asset because on the one hand, it is an asset, inasmuch as it represents a promise by a borrower to repay that loan/credit line (most often with interest). At the same, a loan is also considered a “risk-weighted” asset (emphasis on the word “risk”) because there’s always a chance, no matter how small or large, that the borrower will not repay a bank as agreed.

Banks Follow a 10-to-1 Rule

OK, now stay with me here. To get the highest stamp of approval from the FDIC, a bank’s capital must total 10% or more of its risk-weighted assets. Put another way, for every $10 that it loans, a bank must maintain $1 in capital reserves. For example, if a Bank A has $1 billion in capital, and that bank has made $10 billion in loans (or extended $10 billion in credit to its customers), then Bank A’s capital ratio is 1 to 10, or 10%. But if Bank B also has $1 billion in capital, and has made $20 billion in loans (or extended $20 billion in credit to its clients), then Bank B’s capital ratio is 1 to 20, or 5%. These are critical measures because the FDIC insists that member banks have a more than ample amount of capital on hand to deal with any financial scenario. Thus, the FDIC categorizes banks into five groups:

FDIC Classification of a Bank Capital Ratio

Well Capitalized                                        10% or higher

Adequately Capitalized                         8% or higher

Undercapitalized                                      Less than 8%

Significantly Undercapitalized           Less than 6%

Critically Undercapitalized                  Less than 2%

As you can see, the more credit a bank extends, the more capital it must be able to show the FDIC as proof of its financial strength – especially in the event of potential losses or other unforeseen circumstances. Without a healthy amount of capital, a bank runs into trouble with federal regulators. Once the FDIC labels a bank as “Undercapitalized,” it issues a warning to that institution, telling it to shore up its reserves. If the bank fails to perform, and its capital ratio falls below 6%, into “Significantly Undercapitalized” territory, the FDIC has the right to step in, change the company’s management, and insist that the bank take appropriate steps to remedy its capital shortfall. If a bank’s finances become so dire that its capital ratio drops to less than 2%, and it is deemed “Critically Undercapitalized,” that’s the point at which the FDIC declares the bank insolvent and can take over management of the institution. These illiquid banks are either run by the FDIC, as is currently the case with IndyMac, which failed in 2008, or the insolvent institutions get sold off by the FDIC to another bank.

The Long-Term Implications of the Financial Meltdown

So what does all this mean for you? If you went through the ringer during the downturn, say you lost a good-paying job or maybe you even lost your home to foreclosure, you may have thought that those setbacks represented the single-biggest impact on you resulting from the financial crisis. If you believe that, however, you are sadly mistaken. Don’t get me wrong: Unemployment and foreclosure are major challenges, and they can have a host of far-reaching implications. But in the scheme of things, those are one-time obstacles. In truth, the single-biggest impact on you stemming from the financial crisis is that the credit environment has dramatically changed – mainly because the entire banking landscape has been forever altered. This new economic, banking and credit environment have the power to impact you, your family and your financial dealings for decades to come, likely for the rest of your life. You might miss that old job, or your previous home, but their loss will not impact your credit, or your ability to get a much-needed loan in a decade from now, let alone two or three decades into the future. The new credit environment, however, will continue to have reverberations for decades.

Banks Cutting Back on Lending Are Fighting for Survival

Considering the enormous upheaval the financial community has undergone, can you see why banks, credit card companies and others have become a lot pickier about to whom they lend money? They had to. It’s a matter of survival. Otherwise, making too many bad loans can mean the death of a financial institution – even a century old bank that was once seemingly rock solid. Look no further than the spectacular collapse of Washington Mutual in September 2008 and its takeover by Chase. WaMu was founded in 1889. For many decades, it was considered a great and mighty financial powerhouse. But with $307 billion in assets, and $188.3 billion in deposits at some 2,239 branches, WaMu went under in what is to date the single largest bank failure in U.S. history. In fact, as of October 2009, if you examined the biggest American bank failures ever, where insolvent banks had $1 billion or more in assets, you’ll find that 72% of those bank collapses (more than 7 out of 10!) occurred in 2008 or 2009. These bank failures have cost the FDIC billions of dollars and, some say, threatened the stability of the FDIC, the very institution that is supposed to back up banks.