There has arguably never been a more important time to understand how credit works, and when trying to accomplish this goal, it’s always important to consider the enigmatic “credit score.” While plenty of different companies out there produce a credit score, FICO’s algorithm for producing a score has become the standard for most lenders in the United States. As such, FICO’s scores are the most likely to affect an average American’s chances of getting a loan, and of getting a decent rate for it.
Until recently, though, FICO was very quiet about how it calculated the scores, instead opting to provide vague hints about what would affect it and not giving any specifics. Now, thanks to recent acquiescence from FICO, there are some statistics for average Americans to mull over. For example, as a borrower, when you max out a single credit card, your credit score will drop between 10 and 45 points. This is on the low end of what can impact your score, but something serious like declaring bankruptcy can result in a sickening 240-point drop, along with the realization that you might never get a loan again.
This recent data is referred to as “damage points” data, unveiled on November 12, 2009. What it does is not only tell what could affect your credit score, but also specifically cite what does and gives a point range to back it up. This means that when you as a borrower make certain credit mistakes, you will be able to understand how this will impact your credit score. If you are interested in being proactive, you can even look to see how a specific action you are considering might affect your score, such as opening new lines of credit, maxing out a card, missing a payment or making a late payment, etc.
The “damage points” data has another interesting revelation. If you are a “prime borrower”––someone with a credit score above 700, approximately––you will suffer a greater loss with every mistake you make. As an example, if you are a month late with one of your payments and you have a score well above 700, you might lose 100 points as a result. Someone with a more average score around 650 would only see a drop of 60 to 80 points. What this means is that there is a lot of pressure on those with excellent credit never to slip up, but there hasn’t really been concrete evidence of this before.
Another important thing to understand about credit scores is that they have a significant impact on an individual’s finances, perhaps even more than many Americans realize. The difference between a credit score of 780 and 680 is the potential difference between a 7% interest rate and a 10% or higher interest rate; depending on the size of the loan, that could be tens or hundreds of extra dollars per month going to interest. While all these numbers are hypothetical, the point behind them is nevertheless an important one: your credit score alone can determine whether you are granted an affordable loan, an expensive loan, or no loan at all.
In light of this, it becomes even more critical to understand what your actions mean in relation to your credit score. This doesn’t mean that everyone who is in financial trouble is there because of ignorance about credit scores, but anything that provides more information to the consumer can only be a good thing. In a time when many Americans are struggling just to get by, knowing what will help and what will hurt their credit might be the most welcome news in a long time.
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