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FICO REVEALS CREDIT SCORE AFFECTS
FICO Score
A credit score in the United States is a number representing the
creditworthiness of a person or the likelihood that person will pay his or her
debts. It has shown to be very predictive of risk, made credit more widely
available to consumers and lowered the cost of providing credit. A credit score
is primarily based on a statistical analysis of a person's credit report
information, typically from the three major American credit bureaus:
Equifax, Experian, and TransUnion. Lenders, such as banks and credit card companies, use
credit scores to evaluate the potential risk posed by lending money to consumers
and to mitigate losses due to bad debt. Using credit scores, lenders determine
who qualifies for a loan, at what interest rate, and to what credit limits. The
Fair Isaac Corporation, known as FICO, created the first credit scoring system
in 1958, for American Investments, and the first credit scoring system for a
bank credit card in 1970.
Each of the three credit bureaus may have different information about any
particular person, and there are many different credit scoring models in use,
which means a person may have several different credit scores simultaneously.
The FICO score is primarily used in credit decisions made by banks and other
providers of secured and unsecured credit. It provides a snapshot of risk that
banks and other institutions use to help make lending decisions. Banks may deny
credit, charge higher interest rates, demand more collateral, or require
extensive income and asset verification if the applicant's FICO credit score is
low. Applicants with higher FICO scores may be offered better interest rates on
financial instruments such as mortgages or automobile loans. Lenders usually
establish different credit score cut-offs to determine to whom they are willing
to lend.
The three credit reporting agencies in the United States of America,
Equifax,
Experian, and
TransUnion, collect data about consumers used to compile credit
reports. The credit agencies use FICO software to generate FICO scores, which
are sold to lenders. Each individual actually has three credit scores at any
given time for any given scoring model because the three credit agencies have
their own databases, gather reports from different creditors, and receive
information from creditors at different times.
In the United States, a resident is permitted by law to view their credit report
once a year at no charge by visiting the website
AnnualCreditReport.com. The
individual's "credit score" information is available for an additional fee from
each of the three credit reporting agencies, and their FICO score is available
for a fee at
MyFICO.com
The FICO company sells FICO scores directly to consumers at
MyFICO.com using data from Equifax
and TransUnion. Equifax and TransUnion also sell FICO scores
directly to consumers.
FICO reveals...
Borrowers already knew that late payments hurt their credit scores, but for the
first time, they can now know the extent of that damage.
Did you max out your credit card? Expect a credit score drop of
10 to 45 points.
Declare bankruptcy? Your score will plummet by up to 240 points, and your odds
of getting credit will nosedive with it.
The "damage points" data, unveiled recently by FICO, are part of the most
revealing glimpse into the firm's once-secret -- and still mysterious -- credit
scoring model. The new information discloses how many points borrowers' scores
will drop when they make the most-common mistakes.
Help People Understand' Scores
"I hope this information will help people to better understand FICO scores and
the value for them of avoiding credit missteps. It illustrates key points such
as the higher your score, the farther it can fall if you stumble," says FICO
spokesman Craig Watts. "Getting and maintaining a good score isn't complicated.
We all just need to pay our bills on time, keep credit card balances low and
take on new debt sparingly. "
The greater transparency about FICO scores is important because American
consumers' ability to get credit rises and falls with the number. FICO, the
company that pioneered credit scoring, assigns consumers a three-digit number
from 300 to 850, depending on how well they handle credit. Other companies also
offer scores, but FICO's version is the most widely used by lenders in
determining whether a consumer can borrow, and at what rate.
FICO's credit score has been around for decades, but only within the past decade
have consumers gradually gained access to theirs. Though the raw numbers can be
purchased, how they're figured remains a FICO secret, as closely guarded as the
formula for Coca-Cola. Until Thursday, FICO revealed only broad categories of
factors influencing the score, but not the number of points at stake for
consumers who fail to pay as agreed. The "damage points" information will be
made available through its "MyFICO.com" Web site.
FICO's information shows that bankruptcy does the most serious damage to a
credit score (up to 240 points), followed by foreclosure (up to 160 points)
while maxing out a credit card has the least numerical impact (as few as 10
points).
Those with good or excellent credit -- so-called prime borrowers -- put more
points at risk with each mistake. For example, someone with an average credit
score of 680 who pays a bill 30 days late will see a drop of 60 to 80 points.
But for someone with an excellent credit score -- 780 -- that same delinquency
can send a FICO score tumbling by 90 to 100 points.
The Cost in Dollars
While all the industry insiders stressed that a FICO score isn't the only factor
in determining who gets credit and at what cost (other factors they cited
include the borrower's debt-to-income ratio and whether they have already
established a relationship with the lender), they were able to provide an idea
of what a borrower who had the following credit scores could expect.
For a Consumer Who Started With a FICO Score of 780
" Following a 30-day late payment, the consumer's car loan rate would jump
nearly 3%, costing the borrower $26 more each month.
For a Consumer Who Started With a FICO Score of 680
" Following a 30-day late payment, the consumer would pay
$41 more each month for a car loan.
" Following a 30-day late payment, the consumer would pay as much as
$95 more
each month on a home mortgage.
Some Surprised By the Details
Consumer advocates say it's important for borrowers to know what can damage
their FICO scores. "If they know it in advance, they won't go out and do some of
the things that damage their credit score," says Linda Sherry, director of
national priorities with advocacy group Consumer Action. Even experts found some
surprises in the news. "FICO imposes bigger hits than I would have thought for
being maxed out or 30-days late just once, reinforcing my view that it is a
cruder, blunter instrument than they like to claim. Nevertheless, it is a
powerful, widely used crude blunt instrument," says Ed Mierzwinski, consumer
program director for the U.S. PIRG consumer advocacy group.
Of course, knowing the impact on a FICO score and actually avoiding these
mistakes are two separate things: Amid rising unemployment and other daily
financial struggles, paying bills and staying on-track financially becomes a
much bigger challenge for many borrowers.
Additionally, as Weston points out, consumers with identical FICO scores can
have different credit histories. That means the same slip-up -- such as maxing
out a credit card -- could have different impacts on consumers who have the same
FICO score. In the examples they provided, FICO assumed each borrower had
several active major credit cards, a mortgage, car loan and student loans.
Helping You Make Better Decisions
While knowing the numbers may not keep you from filing for bankruptcy if given
no other choice, the information may help you make the best decision when faced
with a bad situation.
FICO scores -- and the access to credit they provide -- are a valuable asset to
consumers and supply a safety net when incomes are stretched. It's an asset that
needs to be protected, Sherry says, even if job loss or catastrophic illness
makes bill paying problematic.
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