Have you ever wondered why some people appear to have an easier time getting loans approved, while others are stuck with higher interest rates and larger down payments? The answer is usually one small number: their credit score. Lenders use your credit score to assess your credit profile before approving your loan.
There are a number of credit agencies involved in the recording and maintenance of your credit score. The most popular among these is TransUnion CIBIL, which publishes the CIBIL Score. Another analytics firm, Fair, Isaac, and Company (FICO), has recently begun offering credit scores in India. Like CIBIL, lenders may now use the FICO Score to assess your credit worthiness.
What is the FICO Score?
FICO Score is a three-digit number as a measure of your creditworthiness. It analyses your credit history and measures the likelihood of you making your credit payments on time.
FICO scores vary from 300 to 850 – higher scores indicate a higher level of creditworthiness and vice versa.
There are several types of FICO Scores. Lenders either use the base FICO Score or the sector-specific FICO Score. The base FICO Score helps lenders to understand how likely you are to pay back the amount you borrow. Sector-specific FICO Score provides scores as per industry. For example, the sector-specific score for mortgages can help determine how likely you are to pay your housing loan on time.
FICO Scores and how they work
FICO Scores are created using algorithms that consider a number of parameters. These include your payment history, the total amount owed, and how much of your available credit you are using. It also includes the duration of credit history, and the type of credit used (for example, credit cards, loans, and others).
Here is a simple illustration of how your FICO Score is calculated:
Consider your creditworthiness to be a plant. The more you water it (i.e., make on-time payments and pay off debt), the more robust it grows. However, if you ignore your plant (skip payments, incur too much debt), it will begin to wilt (your credit score will suffer).
How FICO's services are used to determine credit risk
So, why is your FICO Score so important to lenders? The explanation is simple: it assists them in determining the risk of providing you with funds.
When you apply for a loan, credit card, or other type of credit, the lender will usually need your credit score. In addition, you may need to provide other information like your income, employment history, and other details. Accordingly, they will decide whether to approve your application and what interest rate to offer.
The higher your FICO Score, the better the terms you are likely to get. This is because lenders view customers with high FICO Scores as less risky because they have a record of appropriate credit use.
