The plea for credit score help was direct, almost desperate. A woman and her husband placed a “fairly large” good faith deposit on a home. But then her credit score fell from 626 to 619, just one point shy of the minimum required by the Department of Veterans Affairs to qualify for a mortgage.
She already had called to remove two old collections reports from her credit file, but that failed to give her the boost she needed. Now the couple was in a bind. If they failed to boost her credit score in the coming week, they would lose not just the chance to buy the house, but their cash as well.
“HELP PLEASE!” the woman, under the username “Butterflieson,” posted on a web forum run by FICO, the company that creates the credit scoring model. “Is it possible to raise score 1 point in a few days?”
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A Step Forward, Delayed
Millions of Americans have solidly good credit; millions more are stuck with seriously low scores. But there are also millions of consumers in the middle—people with scores that straddle traditional dividing lines between “good” and “bad.” A rise or fall of just a few points could save or cost them thousands of dollars in extra interest payments.
It could even change their ability to buy a house or get a credit card.
“If a consumer is applying for a mortgage and they tend to have higher utilization rates on their credit cards, it could (raise their credit score and) make a difference” in how much they pay for interest, says Tom Quinn, Credit.com’s credit scoring expert and formerly the vice president of scoring at FICO.
Especially for people caught in the middle, a recent update of the FICO credit scoring model, called FICO 8, could mean big changes. Depending on the type of credit problems consumers have in their past, some people may receive slightly higher credit scores, which could make it easier to buy a house or get a credit card. For other consumers, the changes will hurt their scores, making it somewhat harder to get credit.
“For individual consumers, it depends,” Quinn says. “For some consumers, their FICO 8 score will be higher than their previous score, some consumers’ [score] will be lower, and others won’t change at all.”
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The Basics I: Who is Fair Isaac?
If you don’t understand what FICO is and how it works, don’t feel bad. The credit scoring system almost seems designed to be inscrutable to the average person. FICO started life in 1956 as Fair, Isaac and Company, founded by engineer Bill Fair and mathematician Earl Isaac to help department stores and gas station chains decide when to extend in-house credit cards to customers.
Even as the basic scoring model has evolved, the basics have remained essentially the same. A credit score is a number assigned to each consumer that attempts to summarize whether that person is worthy of receiving credit. Mortgage lenders, credit card issuers, car dealers and other businesses that extend credit rely on credit scores to decide whether to extend credit—and if so, how much to charge in the form of interest.
While many companies offer different scores, the FICO score has emerged as the benchmark. And FICO itself offers many different types of scores that are customized for different types of loans, including separate scoring models for mortgages, auto loans and even insurance. But they all use similar types of information, including a consumer’s history of paying her debts on time, how much of her available credit she actually uses, how many different types of credit she uses, and whether she has any history of unpaid debts. And they all perform the same general function: To use a consumer’s credit history to try and predict whether she will pay her debts in the future.
[Resource: Get your free Credit Report Card]
FICO scores summarize this prediction in a three-digit score that ranges from 300 to 850. People with lower scores are considered higher risks that they won’t repay their debts; people with high scores are considered low-risk.
For decades, FICO kept a relatively low profile. Then in 1995, Fannie Mae and Freddie Mac, the government-sponsored giants that form the backbone of the mortgage industry, decided to start using the FICO score in their computer programs to help decide which consumers qualify for mortgages bought and sold by the companies.
“That’s really when it took off,” says Evan Hendricks, founder of PrivacyTimes.com, who has testified before Congress on credit scoring issues.
Next came the housing boom. As many banks loosened their lending requirements, they drastically cut back on their own internal underwriting departments, relying more and more on the FICO score to determine whether a consumer was worthy of credit. Soon FICO was marketing its score to everyone from health insurers to casinos, Business Week reported, advertising it as a low-cost way for companies in a broad array of markets to decide who gets credit and who doesn’t.
Which is how a company that most people have never heard of, and even fewer understand, came to play such a pivotal role in the day-to-day functioning of the modern economy.
“FICO is the wizard behind the curtain of the economy,” Matt Fellowes, a scholar at the Brookings Institution, told Business Week. (Fellowes did not respond to calls and emails seeking comment.)
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Image: D Sharon Pruitt, via Flickr.com