Kauai Real Estate Article: FICO

There has been a lot in the news lately about the nationwide mortgage “crisis”. What does this all mean for buying and selling Kauai real estate?

As Kaua`i home prices rose over the past several years, buyers felt the need to “get in”, fearing they would never be able to buy if they waited. Many of these people took out risky adjustable-rate mortgages with low teaser rates because those were the only ways they could qualify for loans. When the Federal Reserve started pushing interest rates higher about two years ago, it started a chain reaction of late payments and foreclosures.

Today, times have changed.

We now look for tighter lending policies, more conservative products and more accounting reserves to offset possible losses. A big part of changes in a borrower’s ability to obtain a mortgage centers around one’s “FICO” score. Just what is a “FICO” and what can you do to assure the good FICO?

After World War II, the number of families grew and so did the need for more housing and retail purchases on credit. Banks and retailers began looking for ways to determine the credit risk of potential borrowers in order to meet this growing need. As a result, community banks & merchants formed their own in-house credit reporting bureaus to compile information about their clients. This was an imperfect system at best. These credit bureaus only compiled negative information about people that often included arrest records, marital history, sexual preferences, and life style choices. Additionally, the banks & merchants did not share information with each other. Decisions about extending credit were made subjectively and sometimes with erroneous information. Obviously, a consistent system was needed to more accurately assess a person's credit risk.

Bill Fair and Earl Isaac recognized the need for a uniform credit assessment system.

Fair was an engineer and Isaac was a mathematician. In 1956 they formed the Fair Isaac Corporation with the purpose of creating a mathematical formula for determining a person's credit risk. Fair and Isaac built a credit scoring system in 1958 using mathematical algorithms. By 1970 they had created the first credit card scoring system. In 1975, the gentlemen developed the first scoring system that took into account the financial behavior of existing credit customers. This score predicted the credit risk of these customers. The result was the birth of the “FICO” score that is accepted worldwide today.

The standard method for calculating a FICO score involves a number of weighted factors:

A FICO score ranges on a scale from approximately 300 to 850.

The median FICO score is around 720; scores above 725 are considered "good" while scores below 600 are considered "bad." Generally, credit information remains on record for 7 years. If a person files for personal bankruptcy, it will show on his/her credit report for 10 years.

The 3 major credit report companies are Equifax, Esperian, and TransUnion.

Better know as credit bureaus, are central clearinghouses for credit related information. They collect information from creditors, and sell credit reports to companies who will use it to evaluate potential clients for credit risk, employment, insurance, licensing, or any legitimate business need. Individuals are also entitled to see what is in their file at the various credit report companies.

In the event of an error on the report, it is the credit bureau’s responsibility to correct the error upon notification. However, the correction may take about 6 weeks.

Whether one intends to apply for credit in the near future or years down the road, it is important to know the components of a FICO, so the when the time is right, the SCORE will be right!