FICO and Rating Agencies
Current Issues in Business
How does FICO work?3
Quick reminder of the financial crisis7
Role of the rating agencies8
How does FICO work?
FICO is a public company that was found in the year 1956 with the aim to help financial services companies by measuring credit risk in a score which is called the FICO score. This stands for Fair Isaac Corporation mainly used in the United States and Canada by lenders and others to assess the credit risks of prospective borrowers or existing customers. Here a three digit number between 300 and 850 is being given to each person that wants a review and a summary of their credit risk. After having calculated this through using several personal files concerning the particular individual, the personal data is collected and this information is split into five categories: 1.Payment history
2.Length of credit history
5.Types of credit used
These five parts concern payment history; how much credit you have used, how long you have had using credit, the type of credit that you had and the most recent applications for a credit. The FICO score of a person can improve if it has been paid on time, but can be a major impediment in acquiring a loan if payments if in the past they have not made payments on time. This part counts for around 35% of the total score and is one of the most important ones in allowing the person to obtain a loan. Around 30% percent of the FICO score is determined by how much credit you have used as well as the type of credit you have had. A person that has applied for several credit cards in a short period of time will be perceived as less reliable and the score will be negatively affected. The period of how ownership of a credit account counts for around 15% percent of the FICO score. Here the longer you have been a customer for the same company, for example a credit card firm, the better the score will be. Along with this, the type of credit you have used has an influence of around 10% percent of the score. If a person has borrowed in the past for home equity, this gives him a much better credit worthiness than someone that has open a credit card right before Christmas with the intention of buying presents. The most recent credit applications count for 10%, so if someone had applied for several credit cards in short period he or she will have a lower score in this part of rating. In short it be said that, the outcome is linked to the change of information in the personal report of the individual. When this fluctuates, it also changes the importance of factors affecting the results as well, because of that, it is almost impossible to measure the exact impact of any one factor in how a particular credit score is calculated without looking at the individual’s complete report. Additionally, it is important to say that FICO scores are mostly being used while applying for a private loan, mortgage, home equity and even for opening a cell phone contract.
As we have just stated, FICO credit scores are necessary to provide information related to all loan takers for supporting the running of whole business of financial loan system. Despite this, there are some very significant critical issues about it which are valuable enough for us to take into consider. On the one hand, the formula of calculating FICO is kept a secret! For instance, one day you are planning to have a house mortgage which is a big step in your life. At this moment, you are excited and go to communicate with those bankers to figure out if you can take the loan, payment terms and also the level of interest rate over it. Therefore, it is easily to notice that it will have a severe effect on an individual and even a household. After that, you are informed that your FICO is slightly lower than 600...