Borrowers Are Out In the Cold

In Grosse Pointe Farms, where property values have fallen markedly, David Stoyka isn't banking on getting access to his home-equity line of credit any time soon. "I'm very concerned that housing values will never come back to where they were." Similarly, Mike and Ann Todd have also felt the crunch, despite good credit scores. Because of tighter credit and the declining value of their home in Shelby Township, Mich., the couple had a tough time getting their mortgage modified in December—they now owe more on the home than it is worth.

With their homes no longer functioning as ATMs, many Americans are looking to credit cards to finance purchases. But as defaults on credit-card debt have risen—in December, 7.6 percent of credit-card balances were either 60 days late or in default, according to Risk Metrics Group—credit-card issuers have morphed into Scrooges. "Given recent market trends, we have changed the underwriting criteria for applicants with certain mortgages and suppressed credit-line increases on accounts with high-risk mortgages," says David Nelms, CEO of Discover Financial Services. About one third of credit-card applications are approved today, down from 40 percent last year, according to Robert Hammer, chief executive of credit-card consultant R.K. Hammer. Borrowers also can expect higher late fees, rising interest rates, and caps on borrowing limits.

Higher fees aren't the only indirect impact of the credit crunch. Credit comes from the Latin credo—meaning "I believe." The now global credit markets, which ultimately dictate the interest rates a homeowner in Cincinnati pays for a $200,000 mortgage or a big corporation in Denver pays for a $2 billion bank loan, are suffering from a crisis of faith. While the credit crunch is driven in large measure by the rising real problems in mortgages and consumer lending, it has a large psychological dimension. "There's been a shift in the collective view of risk," said Zandi.

Today loans aren't simply extended from lenders to borrowers. They are packaged into securities; sliced and diced into pieces, and sold as investments to hedge funds, pension funds, mutual funds and financial institutions. But with many of these funds having been burned on disastrous subprime bets, many of the buyers who helped maintain an orderly market for debt have disappeared, while the survivors are twitchy and suspicious. They have lost faith—in the ability of borrowers to pay back debts, in the ratings assigned to debt and in the companies that insure many forms of debt.

This crisis of confidence is creating occasionally bizarre dislocations in credit markets. Municipal bonds, bonds issued by governments whose interest payments are tax free, are among the safest investments in the world. But in recent weeks, a subsection of the market—the auction-rate market, in which rates reset every week—seized up. Interest rates on the bonds of the Port Authority of New York and New Jersey, which collects tolls on the George Washington Bridge, spiked to a bizarre 20 percent. The lack of ready buyers for securities also explains why people with excellent credit who seek jumbo loans—mortgages larger than the amount Freddie Mae and Fannie Mae will buy—have to pay higher rates than they did a year ago.

Student borrowers who are not eligible for federally guaranteed loans are likewise facing higher interest rates and fewer choices. Lenders in what is known as the private market, like First Marblehead and Sallie Mae, have realized they extended too much credit to students who might not be able to pay it back. Sallie Mae is scaling back commitments to lend to students at for-profit schools like Corinthian Colleges. In a conference call with analysts, First Marblehead said it will increase "fees and rates that borrowers will pay."