Your FICO Scores are a vital part of your credit health. They can influence your credit and loan approvals and what terms and interest rates you qualify for. Because FICO Scores are the credit scores most widely used in lending decisions, knowing what goes into your FICO Scores can help you get a better understanding of how lenders will evaluate your credit risk when you apply for a loan or credit.
Is the FICO system fair? Can software developed over 60 years ago accurately determine our ability to repay our debts? With computers, there is no gray area. Everything is either black or white. There is absolutely no consideration of a person’s character or special circumstances, like a job layoff or an injury, illness or unforeseen circumstances that prevents someone from working and/or losing their financial footing. The FICO system simply looks at data and assigns us a number.
Even worse, the way the system is set up means there seems to be some confusion and misunderstanding on how the scores are assigned to each of us. Even people with excellent payment histories can still see their FICO scores fall. If a bank lowers your limit, which increases your utilization ratio (outstanding debt vs. the amount available), your credit score can drop despite your best intentions.
Fair or not, right or wrong, the FICO Scores are a reality. It’s important to educate oneself and understand how this system is set up. In the end, it’s a game. A game you can win if you know the rules and how to play. Having a high FICO Score is great but it’s not the end all be all especially when you consider that your scores can and will recover and improve from any situation. Case in point, even people with damaged credit due to a bankruptcy find their scores improve so they can be lendable again. In fact, consumer’s who file bankruptcy, Chapter 7 or Chapter 13, often find solicitations for offers of loans and credit within six months after their bankruptcy discharge. How? Because any drop in your credit score can and will restore itself in time. Once you begin to really understand the FICO Score game, it will not seem so intimidating or daunting. Past mistakes will be forgiven so it’s not worth getting worked up over if you find your score dip a little.
Most importantly, FICO Scores are not the only criteria used in evaluating an applicant for a loan. Consider this, imagine two people apply for a loan, let’s call them Borrower A and Borrower B. Borrow A has the highest FICO Scores but no source of income while Borrow B has very low FICO Scores and great income. Based only on these facts, which Borrower presents the least risk to the lender? With these facts alone, it may be difficult to determine. That is why other factors such as Debt To Income (DTI) ratios or income history are also important criteria used when rendering a credit decision. It’s very likely that a lender would prefer someone with a low DTI, stable and secure source of income, and less than perfect credit over someone with a high FICO score but lacking in the other categories. Point is, a credit score alone isn’t enough. Other factors are as important, if not more important, than a mere three digit credit score. Someone with the highest credit score could still get declined if they are deficient in the other categories.
In the end, there is no denying that FICO Scores are important. However, once you understand the credit score game, you can use that knowledge to your advantage and save yourself money.