Scoring Credit Scores

What’s a FICO score?

Source: St. Louis Fed

A FICO score is a way for lenders to find out how creditworthy someone is. It was designed by a couple of engineers to measure a consumer’s risk of default. It weighs your payment history, credit capacity, the length of your credit history, and a couple other factors to come up with a score between 350 and 850.

Lenders use FICO scores because they measure default risk. When banks were local and communities were small, bankers knew who could pay and who might stiff them. But we live in an era of national bank franchises and global capital flows. Your auto loan may be part of an Irish pension’s investment portfolio. The FICO algorithm is an efficient way to communicate credit information, especially about large pools of borrowers.

Source: St. Louis Fed

Credit scores are important. They’re used by prospective employers, insurance companies, and landlords as well as banks. Timely payments matter. Credit is money, Ben Franklin said. Managing your FICO score can be just as important as managing your budget.

Douglas R. Tengdin, CFA
Chief Investment Officer
Phone: 603-224-1350
Leave a comment if you have any questions—I read them all!

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One thought on “Scoring Credit Scores”

  1. Yes, but like a chain saw, unless they are used carefully the operator can be badly hurt. They were used extensively before the crash in 2008. They were the’cover’ used by financial institutions to lull themselves into thinking (and to display to the regulators) they were lending properly. Were rate resets on adjustable rate loans factored in? They certainly don’t consider collateral values (loan-to-value) and economic incentives to strategically default in states with non-recourse mortgage laws. Perhaps they are valid in these more sober times…..until next time….

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