Personal Finance Initiative

FICO score determines your ability to borrow money and the price (interest rate) that you will pay for borrowing that money. Think of it as your GPA as an adult and a good FICO score will save you tens of thousands of dollars over your lifetime. It also is used in many other considerations as this hypothetical freshman discovered during orientation

A Guide to Your Adult GPA

Q: What is your adult GPA?

A: Your adult GPA is your FICO score which measures your past history regarding debt.

Q: When does it start counting?

A: As soon as you begin accumulating debt.

Q: Does debt include all these nice credits cards all these nice companies with the smiling representatives are throwing at me while giving me free T shirts and other items I may never use.

A: You better believe it. Your FICO clock is ticking.

Q: I’m 18 years old. I’ll worry about my FICO score later.

A: Have a good time. You may be trying to come from behind later.

Q: Now you’ve lost me! What do you mean “trying to come from behind”.

A: Think of it as a sports game. Most pros agree it is easier to play with the lead rather than trying to come from behind. It doesn’t matter what the sport is.

Q: Okay, explain it to me, but hurry, I’m anxious to begin college life.

A: Easy. If you handle the credit card properly, you will be in front; if you mishandle it, you may be playing catch up for quite some time. Let’s say the credit card company starts you off with a limit of $300; not bad, even with inflation, you can do a lot with $300. They only request a minimum payment of $6 per month.

Q: I can borrow $300 and only pay $6 per month?

A: Absolutely. As you pay it off, the amount the credit card company requires as the minimum decreases but I’ll use the $6 just to illustrate the concept. If you pay the $6 per month and assuming your interest rate is a low 18% (many cards are higher), it will only take you seven years and ten months and cost you an extra $259. What’s an extra $6/month when you are paying off student loans years after you graduate?

Q: Can I borrow any more than the $300.

A: Well, the scary part to me is that if you establish a payment history, they may actually increase your balance. Let’s say they increase it to $1,000.

Q: Great, I can borrow another $700.

A: Absolutely… and it will only cost you $14/month but I do have to tell you it will take you the same seven years and ten months to pay back the extra $700 and the total interest charge is $604.

Q: No problem. I can get more than one card right?

A: Unfortunately, the answer for now is yes but you will run into the same issues as before. It seems to me like you are willing to commit a lot of money in the future. It could make buying a car difficult.

Q: Huh, what does buying a car have to do with these credit cards?

A; Again unfortunately, I have to bore you with the FICO thing.

Q: OK, explain it to me now. You started with FICO, got into sports, got into silly computations about trivial amounts of money; I wish you could stay focused.

A: OK back to FICO. It is a standardized view of your debt history. Basically it is a scoreboard as to how you have handled debt.

Q: Quit boring me! Who cares about how I have handled debt. A car dealer won’t know how I have handled debt.

A: Au contraire mon ami. They won’t even think about lending to you unless they see your FICO score.

Q: Invasion of privacy, they have no right to that!

A: You are absolutely right unless you want to borrow from them; then they have every right in the world.

Q: OK then, no problem. I have always paid off the minimum on time.

A: You are absolutely right but... they will want to be paid off in less than seven years and ten months; heck, the car might not even last that long and you need slightly more than $300 for the car.

Q: OK, what are we talking about here?

A: Let’s say you need to borrow $20,000 to pay the car off over three years. With a FICO score of 720 – 850,your monthly payment is $607/month. But, you have all these cards with all these small monthly payments, you are probably looking at a FICO score of 590 – 619 which means your monthly payment is $681.

Q: What, an extra $74 per month?

A: What’s a mere $888 per year or $2,664 over the life of the loan? All those pizzas on the credit card tasted good. I should mention to you that you are probably looking at a five year loan which makes the overall difference a lot larger no to mention that you will end up “upside down” on the car during the loan.

Q: What do you mean “upside down”?

A: That is better left to another day. I want to make sure you understand FICO.

Q: I’ll give you another couple of minutes. This is orientation and there are some fun and games waiting.

A: Absolutely understood but as I started to mention, FICO is, as we speak, in a transitional phase but the basic elements making up your score are: Payment History 35% (sorry, you are quite bad here) Amounts Owed 30% (well there is 65% down the tubes; looks like you are playing “catch up”) Length of Credit History 15% (finally something semi-favorable to you) Types of Credit in Use 10% New Credit 10% (the car loan will further reduce your FICO in the short term)

Q: OK, I’ll suffer with the excess payments on the car loan. The damage is done.

A: Actually, not to further depress you, but the car loan is chump change compared to a mortgage.

Q: Okay, I’ll bite. What’s a mortgage?

A: A mortgage is the loan by which the majority of people buy a house. Because it is much larger than a car loan, it will generally be from 15 to 30 years long.

Q: Okay, give me the illustration.

A: My pleasure. With a FICO score of 760 – 850 for a 30 year fixed $300,000 mortgage, your payment is $1,737 per month.

Q: Sad to say, I am starting to understand what you are talking about but... what happened to the 720 – 850 range you used for the car?

A: A longer time period means more risk for the lender so, to put it in poker terms, the “stakes are raised”. The 590 – 619 we discussed for the car loan will, in most cases, automatically disqualify you for a mortgage so let’s say by working overtime and paying down debt, not going out with your friends, becoming a weekend hermit, etc. you were able to raise your FICO score to 620.

Q: Give me the details

A: At 620 for a 30 year fixed $300,000 mortgage, your monthly payment is $2,048.

Q: Well I am only going to stay in my first house for 10 years.

A: You can stay there for a month if you want but... based on your 10 years, you will have made an extra $37,320 in payments over that time. Too bad, that would have been a nice chunk of change when making your move, it could have been a nice car or it could have been invested in the stock market which historically has returned 10% over the long run. Just using a return of 8% and investing the $3,732 for 10 years would return $55,000 to you.

Q: Explain the stock market to me.

A: Another time.

Q: I won’t worry about the mortgage thing; I will be making so much money after I leave Saint A’s that I’ll pay cash for the house.

A: I admire your self-confidence and ambition but I also have to tell you another thing about your FICO score.

Q: Let me guess, wherever I work will pay me less if I have a bad credit score. I won’t believe that for a minute.

A: Actually, it is more complicated than that. You may never get the job in the first place. Currently, approximately 25% of employers check a potential employee’s FICO score and my guess is that percentage will only increase over time.

Q: What in the world does my FICO score have to do with my ability to do my job.

A: Quite a bit actually. The FICO score can be viewed as a measure of your character and integrity, definitely your ability to manage your affairs and certainly your ability to manage money. Let’s say you own a company and are hiring for a key position. Do you want someone in that position that can’t manage their own affairs?

Q: Any other cheerful news on FICO?

A: Well if you have an overdue library book or parking tickets that have been sent to collection, it is going to negatively impact your FICO score. The big cities are actually sending these to collection and believe it or not, some colleges. You will pay more for auto and home insurance with a bad FICO score. Again, a bad FICO score says you are a risky investment for any lender. Would you let money to anyone that might not pay you back?

Q: OK, I get the point. Any other cheerful news on credit cards?

A: Well, not to further depress you but if you don’t pay the minimum or pay on time, you will probably be charged around $39.

Q: Just for one day late?

A: They have the right to do that. If you only pay the minimum, every future purchase begins accumulating interest from the date of purchase so as a rule of thumb, just assume everything you are buying with the card costs you an extra 1.5% per month. How much can that possibly add up?

Q: OK, no need to get wise with me. It is sinking in. So... I should avoid a credit card at all cost?

A: It depends on you. If you believe that you can properly manage one, a no annual fee card with a low minimum is a good way to get started but if you don’t think you can restrict yourself to only buying necessities and paying it off each month, I would wait. Remember the FICO factors. If you start establishing a good payment history and building the length now, the first 80% is in your favor. Back to sports terminology, you will be playing with the lead.

Q: All right, I think I understand but if I have questions later on, who can I speak with.

A: Feel free to e-mail Professor McGuinness. He will try to answer your questions on a timely basis.