What the FICO?
By Keith Bunn Jr.
Originally posted May 9, 2011
Re-posted September 8, 2013
You are always hearing today that you need to maintain and build your credit score, also known as the Fair, Isaac and Company score (FICO). But what do we really know about this score and is it as important as everyone claims it is?
The FICO score was founded by engineer Bill Fair and mathematician Earl Isaac in 1956. It is a tool used to measure how much of a risk there is in offering an individual credit on buying something, like a car, home, TVs, or getting a line of credit for home improvements or starting a business, etc... The higher the score (in the 800’s) the less risk you are and the likelihood of you repaying back the debt you got the credit on is greater. The lower the score (in the 500’s) the greater the risk you are of not repaying back the debt. FICO’s main headquarters is located in Minneapolis, MN, but they have offices all over the world including Australia, Canada, China, Korea, Spain, United Kingdom, and many more.
There are three major consumer reporting agencies used in the United States and Canada: Equifax, Experian, and TransUnion. These agencies keep a recorded on everyone who has taken out loans or made purchases using credit. Each agency has its own credit score based on the information it has received. However, based on personal experience, not all creditors report to all three credit agencies. Years ago, before I learned that getting a car loan is stupid, I tried to get a loan at a car dealership through their finance office. The lady in the office came back out after a while and told me that I didn't have anything on my credit. Now I knew that wasn't true because I had a car loan before, I bought a house before, plus a bunch of other things I had bought on credit. There had to be something on there. Well, we later found out that the finance office only checks Experian and not any of the other ones and evidently, none of my past creditors reported anything to Experian.
So how do these credit scores really work then? Well, lets say for example, that Equifax gives you a score of 650, Experian gives you a score of 720, and TransUnion gives you a score of 700. The general rule is, is that the creditor will use the middle number (our example, 700). That is the number that will be used especially for mortgages. Now again, not all financial institutions will use the FICO score the same way. Of course, they will pull you score the same as everyone else, but sometimes local banks for example may tweek the score using their own formulas and use that number to determine if you’re eligible for a loan of some kind. And insurance companies may use their own formulas, called a ‘clue report’, along with your FICO score to determine your car insurance premium.
Is the FICO score really important?
Well as we read, the FICO score seems to be pretty important right? The answer to that question is both yes and no. In today’s culture, we live at a very fast pace and for most of us, we are impatient when it comes to getting what we want. We want it and we want it now. Larry Burkett said, “We spend the first 5 to 7 years of our marriage trying to obtain the same standard of living as our parents, only it took them 35 years to get there.”
We have to have that nice new car or truck to impress our family, friends, and even that person at the stop light that we’ll never meet. We have to buy a house as soon as possible after getting married because paying rent for an apartment is just throwing good money down the drain. We have to have a credit card to rent a hotel or car, or go on nice vacations. So, if you believe all that, then your answer to the above question would be ‘yes’. I have talked to a lot of people who believe that and they are up to their eye balls in debt trying to maintain a credit score and/or maintain an image of looking like they are in a good financial setting. They have multiple credit cards, multiple car loans, multiple mortgages, etc…
But what if I told you that even though the FICO score is doing exactly what it’s supposed to do, having a large FICO score is not an indication of you winning financially. In fact, for a good number of people, it means the opposite. You see, the FICO score is really an, I love debt score. If you look it up on FICO.com, you will see that your score is broken down into 5 categories. 35% of your score is based on your payment history. 30% is based on your debt levels. If your level of debt gets too high, your score gets harmed. If your level gets too low, your score starts to go away. 15% is based on the length of time you've been in debt. 10% is based on the type of debt you have. And the last 10% is based on any new debt. What percentage is based on how much money you have saved or how long you've worked at your present job? It doesn't! Wouldn't you think that was important too?
Dave Ramsey gave the best example that I know of to explain what this means. He said that in the past 20 plus years, he has zero debt and pays for things using cash only. By doing so, he has freed up his largest wealth building tool, his income. So today, he is now a multimillionaire. He continues by saying that if he wanted to go down the street and rent a studio apartment, a $500.00 per month apartment, the apartment manager would more than likely look to see what his FICO score was, but because his score is zero, they would probably not rent him that apartment even though he has enough money to write a check and buy the whole complex.
You see, you could win millions of dollars playing the lottery, inherit millions when your long lost uncle passes away, or receive a million dollar a year raise from your employer and your FICO score won’t go up one point unless you use that money to go into debt and stay in debt your whole life. There is something wrong about that. So my answer to the question, “Is the FICO score really important?”, would be ‘no’.
My wife and I are no longer borrowing money, we are paying down our debt, and we are being patience and paying for things we want or need with cash. Overtime, our credit scores will cleanse themselves and our scores will become zero. It’s up to you now, you have to make the decision of what you believe. Continue to worship at the altar of the great FICO or reduce your financial risk by not borrowing anymore money, pay down your existing debt, use cash for purchases, and save money. The choice is yours.
The reason I do this is to give people hope and to try to inspire others. To make them think about their finances, whether they are young or old, so they can win financially.
If you have any questions for me about my posts or if you need help learning how to live on less than you make and creating a budget, you can call me at (616) 454-2046 or e-mail me at firstname.lastname@example.org. I’d be happy to do what I can to help!
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