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The FICO Score Flaw

September 9th, 2007 · 5 Comments

How often have you heard someone talking about their credit score? Often that person is applying for a mortgage and is concerned about the score. The Fair Isaac Corporation (FICO) invented the best known and most widely used credit score model in the United States. Wikipedia expands on the FICO score below:

A FICO score is between 300 and 850. According to Fair Isaac, the median score is 723 (half of scores above and below) whereas according to Experian (using the Fair Isaac risk model) the average credit score is 678 (lowest scores are farther from the median than the highest scores). The weighting of the score is broken down as follows:

  • 35% — punctuality of payment in the past (only includes payments later than 30 days past due)
  • 30% — the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
  • 15% — length of credit history
  • 10% — types of credit used (installment, revolving, consumer finance)
  • 10% — recent search for credit and/or amount of credit obtained recently

You can see many components make up a FICO score. It can take six months or longer to improve or worsen a score. If you file for bankruptcy it can take seven or even ten years to wipe your FICO slate clean and even then it will often be asked on loan applications. The score is similar to a financial report card banks use to determine your risk of defaulting on a loan. The lower the score, the higher the risk of you falling behind on the loan.

So, what’s the flaw with the FICO score?

Before I answer that question, let me tell you about one of my goals. This goal pertains to my FICO score. My goal is for my FICO score to become zero. You may be saying WHAT? Is this guy nuts? Why would anyone want to ruin their credit rating? Plus, the rating only goes down to 300…why shoot for zero??!!

The flaw in the FICO score is that it’s a loser’s game. It is merely an indicator of how well you manage the revolving door of debt. Just like getting bad grades on a report card, you’d really prefer that no one has to see this private matter. If your score is high, you apparently don’t need to borrow money because you consistently pay it back promptly.

The flaw in the FICO score is that it shows you have debt. It might be well-managed or it may be poorly-managed. Either way, you have debt.

My goal is to have no debt. In the next month or two, my family will have no debt except the house and even the terms of that loan are being re-evaluated by me. My plan is to go as long as I possibly can without borrowing any money. Not from a friend, not from a relative and certainly not from a bank. If someone goes years and years and years without borrowing money eventually that person will have no no track record for a FICO score. Banks will have no clue about your ability to pay back a loan and that’s a good thing. I realize that this could be a decade away or more for me to get a FICO score of zero.

Here’s the ironic part: a millionaire who has not borrowed money for many years would also have a credit score of zero. Yes, a person with a net worth of millions of dollars cannot get a loan from a bank due to our financial culture based on that score. No track record, no loan.

The next time someone discusses the concept of the FICO score mention that this is a score you’d rather not even have.

Tags: Credit Cards · Money

5 responses so far ↓

  • 1 Henry Good // Jan 2, 2009 at 4:05 pm

    You are right. The FICO score shows how well you play the debt game. But, it sure is handy to be able to borrow money when you want to build a business. I don’t know that I agree with you that we should want a zero score. I think that it is useful to have the options to borrow for great purposes. Having a high credit score gives me more freedom than I would have if I didn’t.

  • 2 mhutter // Jan 4, 2009 at 11:58 pm

    Henry, I built up my business paying cash for everything along the way. Aren’t you, in a way, crippling the business by hindering it with debt right at its inception?

  • 3 Richard Armstrong // Jun 26, 2009 at 6:54 pm

    The answer to Mr. Hutter’s open question is, “it depends on how you use credit in your business.” Businesses should not, and hopefully do not, use revolving credit the way that John Q Public has come to use it. However, it is perfectly legitimate and responsible to want to have a line of credit at the bank (secured or unsecured), provided the business advances only against collectible receivables. And, regrettably, banks won’t set up such a line without a FICO score. I share your goal of becoming debt free, but if I cannot finance receivables that will enable me to do so, I increase the chance of never achieving that goal.

  • 4 Paul Kupetsky // Dec 24, 2013 at 11:26 pm

    I believe paying cash is the best option. I have heard many times “If you can’t pay cash for it, you can’t afford it”My parents raised 5 boys on no credit all cash. I have a multi-million dollar business and never took out a loan. It’s called non-traditional and the right vehicle.

  • 5 Nightvid Cole // Apr 14, 2014 at 7:32 am

    You are not debt free if you have a mortgage – sorry.

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