Credit Score Factors: Payment History

It might seem counter-intuitive, but the most important investment decisions that a personal investor will ever make tend to revolve more around debt than they do actual securities. This is because of the way in which our debt and credit capacity makes up for such much of our total net worth.

When looking at how it is that he sheer volume of money required to service mortgages, student loans, and credit cards outweighs the size of a personal investment portfolio, it becomes apparent how it is that managing and reducing that debt load now can create as much future benefit to our financial position as a well placed investment. That being said, credit still provides a fundamental value to enable lifestyle and financial goals, and should therefore always be kept available as an option for facilitating a long term financial goal.

In order to help personal investors understand how it is that they can maintain effective access to credit, we’re going to use this week to discuss the specific aspects of FICO-based credit scores that can have the greatest impact on your ability to access debt. By maintaining these aspects of credit-worthiness, an individual is able to borrow at the most cost effective rates, and access the most flexible lines of credit.

When evaluating your ability to borrow, it is important to remember that FICO scores will only provide a benchmark for a lender to make their own decision off of. However, by understanding the different borrower classifications that are described under the FICO model, we can begin to have a better understanding of what to initially expect as an outcome. In general, lenders will split FICO scores up into six different classes of borrowers.

The first class of borrower is one without any history of credit or borrowing. While these individuals are considered to be very risky, they are considered to be better able to pay off debt than those individuals that have consistently shown tendencies of insolvency in the past, or an unwillingness to cooperate with lenders after taking on an obligation. Individuals with such unfavorable tendencies are the ones that are considered to have ‘bad credit’, and will not generally be the recipients of loans without the substantial placement of collateral.

On the other hand, individuals without credit might have access to credit without requiring significant amounts of collateral so long as a respectable down-payment is made, and a somewhat unfavorable interest rate is agreed upon.

The next class of borrower is generally labeled as being a ‘sub-prime’ borrower, in that their score is below the ideal lending rate (called prime), but they still present an acceptable amount of risk to the lender as an investment. Sub-Prime borrowers have garnered a bad reputation over that last decade is being extremely risky, but it is important to separate the complexities of the mortgage crisis out from borrowing on an individual level.

By borrowing at a sub-prime level, an individual is usually in the process of building up their credit history, or has in the past fallen upon circumstances that made repayment more difficult. That being said, Banks are usually willing to work with Sub-Prime borrowers by providing manageable loans with flexible terms to accommodate repayment. The only down-side is that they will not have the favorable rates that are offered to Prime Borrowers.

Prime Borrowers are those who have demonstrated a tendency towards repaying loans consistently, and have shown that they have a respectable amount of experience in dealing with debt itself. By proactively managing their debts, Prime borrowers have earned the privilege of borrowing are attractive rates, with flexible terms, and without the need for significant collateral. From here, individuals can even continue to build their credit up into categories that allow them to borrow on particularly favorable terms reserved for individuals with ‘Prime-Minus’ rates (interest rates less a certain percentage) or at ‘Excellent’ rates.

In these final two categories, borrowers are in a position to take on discretionary rates because of their strong relationships with lenders. That being said, because these individuals control such financial stability on their own, they generally do not require credit to maintain their standard of living, and can be somewhat rare.
Regardless of where a borrower’s credit rating stands, it is important to remember that there are always options available for borrowers to either access funds, or improve their ability to access funds in the future through credit building strategies and proper financial planning.