What is the importance of the FICO score?

According to the Consumer Federation of America, a FICO score determines the likelihood that a person will repay money loaned to him. Consumers with higher FICO scores are considered less risky and are more apt to obtain loans with better interest rates. A low score can make it difficult or impossible to obtain needed credit. The FICO score ranges between 300 and 850.

History

Fair Isaac Co. introduced the first public FICO scoring model in 1989 as Beacon at Equifax. The company was created in 1956 by engineer Bill Fair and mathematician Earl Isaac under the notion that "data, used intelligently, can improve business decisions."

Significance

Mortgage lenders, credit card companies, banks, merchants, finance companies and insurance companies use FICO scores to determine whether a customer is worth the risk of loaning credit or insuring. MyFICO.com reports that 90 percent of the largest banks use credit scores in making loan decisions. It also indicates that consumers can save thousands of dollars over the life of a loan just by having a good credit score.

Structure

FICO scores weigh negative and positive factors in a person's credit history. A combination of those factors determine a person's FICO score.

Positive Impacts

Consumers who have a long credit history and pay more than the required balance will attain higher FICO scores. The scores also increase when the consumer has a good balance of installment loans, revolving accounts and mortgage loans which are paid on time. The on-time payments show that the consumer is able to handle his debt well.

Negative Impacts

People with a history of delinquent or no payments get lower FICO scores. Other negative impacts on FICO scores include bankruptcies, legal judgments, collections and liens. FICO scores are also lowered with too many outstanding credit accounts and loans, and balances that are too high in relation to the credit limit. Loans from finance companies can also cause the FICO score to decrease. Finance companies--institutions that loan money at higher interest rates than banks--are considered high risk since their lending requirements are more lax. Consumers who obtain these type of loans are considered less creditworthy in determining their FICO score, since they are borrowing from companies that take on more risk.

Benefits

FICO scores are easily obtained via the Internet and can provide financial institutions immediate information on a customer's credit worthiness. As a result, decisions can be made quickly on loan amounts and interest rates. It is a standard used by most industry leaders so decisions are consistent. Credit decisions are objective since they are based on factual data.

Source:

FICO

Federal Trade Commission

MyFico.com

More Information:

"The Road to 850," Al Bingham, 2007