In the late 1940s, engineer Bill Fair and mathematician Earl Isaac met while working at the Stanford Research Institute, the legendary post-war industrial thinktank.
The two of them developed an algorithm, using a credit scoring system, that helped predict the chances that a borrower would repay a loan. In 1958 they founded Fair, Isaac and Company and soon began pitching their scoring system to financial institutions.1
Fast forward 30 years. The company shortened its name to what its customers were calling it, FICO, and was well on its way to becoming the standard measure for consumer credit worthiness—used for everything from credit cards to mortgages.
Today, credit bureaus (also called credit agencies) collect data relevant to your risk as a borrower. Similar to the original FICO system, these firms track your income and borrowing-related data and generate your credit score. There are many credit bureaus, with the big three being TransUnion, Equifax, and Experian.2
Credit scores range from 300 to 850, with the higher number representing less risk to a lender. A score of 760 or higher is considered excellent.
Potential lenders, of course, want to know your credit score. A higher number may qualify you for a lower interest rate. But now insurers, utility companies, landlords, and potential employers are all requesting access to people’s credit reports. In the population as a whole, people with higher FICO numbers tend to be more responsible in other things. So, a better score can help you get lower insurance rates, have an easier time setting up utilities, and even give you a leg up on a job application.
In the past, the FICO system has looked at things like your payment history, current level of debt, and any defaults or bankruptcies. But recently they’ve updated the algorithm to include more short-term risk factors like late payments, rising debt levels, and debt in the form of unsecured loans.
According to The Wall Street Journal, millions of consumers could see their scores rise or fall as a result of the changes.
“Consumers with already-high FICO scores of about 680 or higher who can continue to manage loans well will likely get a higher score than under previous FICO versions. Those with already-low scores below 600 who continue to miss payments or accumulate other black marks will experience bigger score declines than under previous models.”3
Some personal finance experts have complained that a high credit score just means you’re good at getting in debt. It’s also true that getting out of debt should be one of your goals as you move towards a successful retirement.
However, with FICO scores now being used widely outside the loan industry to assess the cost of other services you may need, it’s probably beneficial to do the financially responsible things that keep your credit score number high. Contact a member of our Wealth Management team to help you with budgeting and debt management planning.
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