One very important element in your overall credit worthiness package is your FICO score. But what exactly is that and how does it affect your debt management choices?
FICO is an acronym formed from the letters of its founder, the Fair Isaac Corporation. It is a number between 400 and 800 that ranks credit worthiness according to a proprietary algorithm invented by the company, with 400 being worst and 800 being best. Other companies now have their own variations.
Though the details of the algorithms are closely held trade secrets, over the decades many people have reverse engineered several of the important factors. Any late payments will lower your score, and the more of them and the later they are, the more heavily the score is affected. The total amount of debt carried per month is another element. A less important factor is the number of credit cards and credit checks performed.
Any score below about 620 is considered marginal and below 580 is decidedly poor. 720 and above is very good to excellent. A range between 620 and 720 represents a kind of gray area, where items other than your FICO will play a more significant role in loan decisions.
Banks, mortgage companies, credit card issuers and other lenders will use your FICO score as a very important criteria for deciding whether to make a loan, and at what interest rate. Other things being equal, the higher your score, the better interest rate you can obtain.
Of course, many times all other things are not equal. Prevailing interest rates in general, the current demand for loans, the general economy and other factors have a heavy influence on the willingness of lenders to lend and at what rate.
How the current economy and credit crunch will affect you
The entire lending industry has undergone at least two significant shifts in the last 20 years. With the increasing use of computers and modern financial techniques, underwriting loans is done very differently today. Also, not surprisingly, the Internet has shifted finance to a very different mode of working. However, most significant has been the fallout from subprime loans, the housing bubble burst and the resultant economic domino effect this has had. Without an excellent FICO score and solid employment history, it will be very difficult to obtain credit for at least the next decade. Those with marginal credit will find current credit card limits reduced and interest rates raised.
Because of these changes, the FICO score remains a primary tool for lenders. It may not determine the final decision, but it definitely influences the 'first cut' when presented with a stack of applications to approve or disapprove.
Fortunately for those who have slipped up financially, there are alternatives. Though your FICO may be low, you may have several options. The first thing to do is set into motion a plan to improve your score. Even though you may be unable to obtain credit - even though you may not want to obtain credit immediately - your FICO score is a work in progress and when you go to obtain credit, you want it to be as high as possible. There's no better time than now for working on improving your credit rating and reducing your debt-to-income ratio.
As you work to remove those outstanding overdue debts - either through paying them off or negotiating with the lender - your FICO will gradually improve. The age of 30 day past due, 60 day past due (or longer) late payments is a factor in calculating your FICO.
At the same time, you can shop around for lenders willing to take a higher risk by lending you money. The downside is those loans almost always carry a higher interest rate. Your best approach is to try to forego borrowing for as long as possible while you work to improve your debt situation. Your FICO will follow suit.
Components of your FICO credit score
