As a financial advisor, you likely have some clients who are eager to invest and plan for the future, but go through seasons when they struggle with cash flow. Clearly, the latter can significantly impact the former, and when that client also has a poor credit score, the challenges mount.
A bad credit score typically isn’t the result of one poor decision or bad transaction — it worsens over time through a series of events. Perhaps a client fails to pay bills on time, maxes out credit cards, has excessive debt or has a foreclosure in their credit history.
The consequences of poor credit scores have the ability to compound a situation, making it difficult for an individual to get ahead. In worst case scenarios, landlords deny rent applications or utility companies won’t extend their services. Some employers who review credit history as part of the job application process might pass by an applicant with poor credit in favor of another who scores higher.
One of the largest implications of poor credit, however, is that the lower the credit score, the higher the interest rate on loans. Many traditional lenders may simply refuse to extend credit at all, forcing some individuals to resort to nonconventional high-interest loans from questionable lenders, perpetuating their situations.
How can advisors provide guidance to clients who may find themselves struggling to improve their credit before it further threatens their long-range goals? Use these tips.
1. Assess Current Behaviors
The first step in addressing a client’s poor credit history is potentially the most difficult. It’s critical to address potential behaviors that may have gotten them to this point. Granted, there are times when, through no fault of their own, they may find themselves in a bind. But remember, most low credit scores are the result of multiple poor decisions that often snowball into an avalanche of unintended debt and regret.
A caring yet candid conversation to help your client understand and identify why their credit score is tarnished may help them avoid repeating those mistakes again. There’s little use in trying to repair someone’s credit history if the behaviors that lead to them continue to happen.
2. Review Credit Scores
Boosting a credit score, even by a few points, may make a significant difference in how lenders view your client’s credit, so consider having your client confirm where they currently stand.
There are several resources available to help your clients review their credit reports without affecting credit scores. Individuals are allowed to request a free credit report once a year from each of the three nationwide credit bureaus: Equifax, Experian and TransUnion.1
To the surprise of some, these credit reports may contain incorrect information. If that’s the case, your client can dispute the information and request that it be deleted or corrected. They should contact either the credit bureau that provided the report or the company that submitted the inaccurate information.1
3. Cosign a Loan
Your client may be able to borrow money from a friend or family member at a reasonable rate to help them pay off debt and build up their credit. Such an agreement may not be practical, however. If that’s the case, perhaps another party would consider cosigning a personal loan. If the other person has a good credit score, they’ll likely qualify for a lower interest rate.
Such an agreement requires trust and an understanding that if one party defaults on their end of the bargain, the other person will have to foot the bill alone. That stresses the importance of drafting a written plan showing how your client will make payments. This might include divulging their income statement, budget and other financial information to help assure the other party of their intentions and, more importantly, ability to follow through. When payments are made on time, in combination with other good financial practices, your client’s credit score will likely improve.
4. Shop Around and Negotiate
Just because a client’s banker denies a loan or offers a high interest rate doesn’t mean that every financial institution will. It’s important to check with other lenders to see where they stand.
As with a cosigned loan, a written plan showing a client’s detailed strategy and steps they’re taking — and will take — to remedy their past indiscretions may go a long way. Showing recent patterns of fiscal responsibility and that there’s a plan moving forward might help convince a lender that your client is a lower risk than their credit score might indicate. In general, smaller institutions may have more flexibility than bigger corporations when it comes to their lending processes and ability to negotiate. In either regard, there’s no harm in trying.
5. Create a Plan to Pay Off Debt
Simple steps can help improve a credit score, like paying bills on time and spending down debt. Help your clients create a financial plan that helps to meet their immediate needs while also including a vision for the future.
It needs to start with a hard look at their budget and where they’re spending money. They’ll likely need to make sacrifices to set them on the path to financial freedom. Big and small steps combined can make a major difference, like paying more than the minimum payments, minimizing discretionary spending, using a debit card or cash instead of a credit card, consolidating debt, or even selling unneeded items or downsizing to reduce expenses.
Don’t forget to include saving as part of the budget, even if it’s only a small amount each month. New behaviors need to be formed to help set your client up for success and to keep them from returning to their old habits, especially once they reach their goals. They’ll likely never regret forming the habit of saving, as it’s a key to building a nest egg for the future.
Using client behaviors to uncover financial solutions is what the Behavioral Finance Approach (BFA) is about. We’ve curated several resources based on this scientific approach to behavioral finance that can also help your clients understand their core values, a foundational step in understanding the how and why behind decision making. Access it below.