FICO Explains How Bad Decisions Can Affect Credit Scores

   

Posted: Dec 18, 2009

Consumers who may have felt they were in the dark about how their financial actions affect their credit scores now have some specific guidelines from the company that writes the rules.

FICO, which is the acronym for Fair Isaac Corporation, recently released a scenario-based explanation of how certain consumer credit decisions could cause a score to fall. The scenario set up by FICO presented two fictitious people: Alex, who has a credit score of 680, and Benecia, whose score is 780. (The higher the score, the better.)

Differentiating the levels of their credit scores is important for understanding how events like foreclosures and declaring bankruptcy can affect consumer credit. According to FICO, people with a higher credit score can expect negative financial events to lower their score by a greater number of points. 

For instance, let's say that Alex and Benecia each charged one of their credit cards to its maximum credit limit. Alex could expect his credit score to fall 10 to 30 points, while Benecia might see her score decrease 25 to 45 points.

"That's because Alex's lower score of 680 already reflects his riskier past behavior," FICO noted. "So the addition of one more indicator of increased risk on his credit report is not quite as significant to his score as it is for Benecia."

Foreclosures can also decrease a person's credit score. In the scenario presented by FICO, Alex's score might drop between 85 to 105 points, but Benecia could expect a decline of 140 to 160 points.

By far, the worst financial misstep presented in the scenario is declaring bankruptcy. If Alex declared bankruptcy, his score could fall as much as 150 points, while Benecia could see her score decline by 240 points.

"That's because the FICO scoring model generally gives the most weight to payment history when calculating the score, and bankruptcy is included in one's payment history," FICO said. "Also, a bankruptcy often involves more than one credit account, compared with a foreclosure, which often involves just a single account."

Along with negative occurrences, there are a number of other factors that can affect a person's credit score. For example, credit utilization is one thing that is considered when determining a credit score. When a person uses a higher percentage of his or her available credit, that person's credit score is likely to be negatively affected.

Other variables that factor into a person's credit score include how many loans and credit cards they have and whether they've missed a payment. The length of time a person has had an account and how long ago they got their first loan are also factors in their FICO score. Applying for new sources of credit, including credit cards, auto loans and mortgages, can also adversely influence a person's credit score.