You know in old movies how customers would come into the general store and wouldn’t have to pay? Then the owner would put it on their tab knowing they were good for the money? In simpler times, bankers lent based on interpersonal trust.
Now, you’re a number — your credit score or “FICO.” Computers speed decisions and help take personal prejudice out of the equation, but they also make mistakes, which can compound fast, as seen with identity theft.
Every time you swipe your credit card, bounce a check, open a bank account, apply for a loan, or even get a cell phone, data is collected by credit reporting agencies.
Information in the databases of the so-called “Big Three,” Equifax, Experian, and TransUnion is analyzed for behavioral patterns so as to reduce each individual to a score that is supposed to represent the risk of lending to him or her. Various scores exist, but the FICO is most popular.
Every lender has a different strike point, depending on the risk it’s willing to take.
Decisions to grant credit are rarely based on your FICO alone, but having a good credit rating—a high score—is vital to your financial well being. It impacts other areas, too, as landlords, typically, and employers, sometimes, check your credit score to assess you.
College is the best time to start building your credit history/rating because banks are receptive to you. Young people are valuable to banks, who are trying to build new relationships with emerging consumers.
Unpacking the Credit Score
- What it is: a measure of your risk to lenders,
Ranging from 300, “highly risky” to 850, “safe bet” on the industry-standard FICO score.
- How it’s derived: analyzing your credit behavior.
No recorded behavior? That’s the unknown, therefore “risky”.
- Why do I care? No credit score, no credit; a low score means a high interest rate.
How Do You Score?
You have to buy your FICO (despite the “free” homepage offer).
Your credit report is free once a year from the ratings agencies–so long as you go to annualcreditreport.com. Check it for errors that are costing you or possible identity theft issues and alert the appropriate agencies.
The Credit Score “Catch-22“
You know how it seems you can’t get a job unless you’ve had a job, but how do you get a job if no one will give you a job?
There’s a parallel with credit scores. Starting off, everyone’s loath to give you credit until you’ve shown a history of handling it well. Don’t worry, once you do handle it well, you’ll be flooded with more offers than you want!
Alternatives to the FICO Score
In response to the Catch-22 detailed above, scores other than FICOs are being developed.
- Experian’s VantageScore can use just one month of behavior data, versus at least six normally—a boon for students and others with little credit experience (a “thin file” in industry speak).
- Suze Orman’s just introduced Approved Prepaid Mastercard debit card shares data with TransUnion and the hope is that, later, it will feed into FICO scores.
- Human Capital is one of several companies trying to make a broader assessment of creditworthiness and factors in things such as college majors and grades into its HCS score.
Note: 1 and 2 below make up 65% of your score
1. How you’ve handled credit (aka your payment history).
2. How much total debt you have versus how much credit is available (aka credit utilization ratio).
3. How long you’ve had credit.
4. How much new credit you have.
5. What types of credit you have.
Strange But True: The acronym FICO has nothing to do with the credit rating process; it’s just the initials of the San Francisco company that created the most popular credit score, Fair Isaac & Co.