It is widely acknowledged that your FICO score is one of those numbers that defines you financially. The number is a three-digit figure that varies between 300-850 and is assigned by lenders to evaluate your creditworthiness. Holders of high FICO score stand better chances of being issued credit cards, loans, and other forms of credit at a favorable interest rate. But should your whole financial life depend on this mysterious three-digit score? Now, let’s look at the advantages and disadvantages.
Advantages of Using Your FICO Score to Make Financial Decisions
It gives an overall picture of creditworthiness. While the formula used by FICO to arrive at the score is trade secret, there are five factors that experts believe it considers: payment history, amounts owed, length of credit history, credit mix, and new credit. This is why your three-digit score represents how credit has been utilized in the past at one glance. A high score shows that you are a responsible credit user and make timely payments while a low score raises concern among credit givers including landlords.
Lenders make extensive use of it. FICO score is widely used today as a benchmark for all major lenders, including mortgage, automobile, credit cards, and personal loan lenders to assess the credit risk of applicants. Thus though it is not the only credit score available with the bureaus, it is the one that counts for most financing or credit applications. It also gives one the tip of whether they are going to be approved or not.
It can cut down costs. The more points you have, the better your odds of being approved for lower interest rates and thus paying less in interest charges over the term of the loan. For instance, according to FICO, a borrower with a score of 759 to 850 will expect an interest rate of 3. 936 percent on a 30-year, 300000 dollar mortgage as compared to 6. 622 percent for a borrower with a score of 620-639. That is a difference of over 116,000 in interest payments over the loan term.
Drawbacks associated with utilizing your FICO Score as a financial standard
It's a moving target. A big disadvantage of the FICO score is that it changes every month every time a lender pulls your credit report or reports information to any of the credit bureaus. This can be as simple as applying for credit or utilizing credit limits more than 30 percent of the time, and bring it down a few points for a while. Thus, focusing on daily or even monthly changes in scores is usually unproductive.
It was also earlier noted that the precise algorithm of FICO score calculation is kept secret by the Fair Isaac Corporation. The consumer has no idea what is going on with their three-digit score or what they need to do to increase it by 10 points and beyond. The best advice is to follow the good credit habits stated above such as paying all the bills on time and maintaining low balances. But you cannot target which factor is increasing or decreasing you.
It doesn’t give the full picture of your financial situation. While your FICO score provides some information on payment patterns and debts it does not reveal your complete financial picture which includes income, savings, assets, and your ability to pay your bills and other emergencies. That is why, when evaluating your creditworthiness, lenders do not solely focus on your credit score but on such factors as debt-to-income ratio, the size of the down payment, and your employment record. Thus, it makes no wise to allow this myopic three-digit number to dominate all your money decisions. Do not make decisions based on individual aspects of your financial situation but rather consider the overall picture.
It is not the only score in town. However, to the layman’s mind, credit scoring is a product of FICO, although it is important to note that there are different credit scoring models all crafted by various companies. For instance, there is the VantageScore, which ranges from 300 to 850 and employs factors somewhat different from FICO models; specialized scores include FICO Auto Scores and Bankcard Scores that are designed to predict risks in the respective spheres. Many lenders use their internal scoring systems for credit scoring for their borrowers. It means that one can have a desirable credit score with one credit bureau and then find out he or she was rejected for a loan with another scoring algorithm.
Should You Go by Your FICO Credit Score?
Overall, the FICO score, has a good use in providing a snapshot of how the credit health is and could be used as a rudimentary measure of the interest rates and loan terms one is likely to be offered. However, it’s not to be used as the only reference point or as the navigational tool for directing your money affairs.
Employ your FICO score more as a basic reference and signal of potential financial trouble rather than a predictor. For instance, a decline in your score will force you to review the reports to look out for fraud or mistakes. If your score is moving out of the Good or Excellent range, it may be a good idea to improve your credit behavior before applying for a large loan.
The frequency of checking the score is not a big deal since people can check it quarterly or so to check for surprises or improvements. The only thing you should avoid is to overreact each time there is a change up or down. You don’t have to start panicking and make illogical decisions such as closing credit cards or stopping credit applications every time you notice a slight decline in your FICO score.
Regarding finance and credit management given the borrowing decision, it is always better to be guided by one’s full financial profile, not by one’s single summary profile of the payment history. When you have the big picture of the money, then you can be in a position to make the right decision that would improve your life. The FICO score is useful, but it is not the only thing to consider when designing your financial destiny.
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