FICO is an abbreviation for Fair, Issac and Company of San Jose, California. Founded by Bill Fair and Earl Isaac in 1956, the company specializes in data analytics to derive consumer credit risk and its “FICO Score” has become a fixture in consumer lending within the United States. 

While the exact algorithm is a trade secret, financial analysts have determined its basic components, namely: credit utilization, timely repayment of obligations, number of open accounts, and number of past due accounts. 

Basically, it’s a numerical designation for how you handle debt but has grown to be used for decision making in rental applications, cell phone plans, and car insurance rates, all things that arguably aren’t lending situations. A high FICO score is seen in modern American life as a measure of your financial health. 

It isn’t. 

For one thing, the FICO algorithm is about your relationship with debt and other measures of financial health like income, net worth, or savings aren’t taken into account. It is entirely possible for people to have an 850 FICO who can’t come up with $850 in cash, or even have an income.. For example, many people who pay off mortgages or car loans often find their FICO score drops due to lower credit utilization and people nearing retirement often find their scores dropping as they reduce or eliminate debt and maximize savings. When I paid off my mortgage, my score dropped 70 points.

An acquaintance was shocked to find that after 20 years of on-time payments and assiduous utilization of credit. Once he paid off the mortgage and cancelled several open but unused credit lines…his score plummeted to a mere 630.  A 630 FICO score would indicate he’s a credit risk and could jack up his insurance rates, his cell phone bill, or make renting a temporary apartment problematic should he need to work out of town for a period of time. 

The fact he has a net worth in the 7 figures and enough cash on hand for several years of expenses notwithstanding. 

In fact, after a couple of years of not having any open credit accounts, your score becomes “indeterminable”, the same as any 18-year-old without any credit history at all. Go figure that one. The only way to maintain a high credit score and demonstrate creditworthiness is to continually borrow and repay money with interest…which hardly sounds like a winning formula for financial independence.