FICO scores were supposedly designed to assess peoples ability to pay back money loaned to them by others—banks, credit unions, car dealerships, etc., etc. Even if that were originally the only intent of the developers, your FICO score now does much more. Let me explain.
Joe is forty years old; he is a homeowner with a mortgage, a wife, two kids, two cars, and a shiny new bass boat parked in his driveway. He and his wife share two Visa cards and a department store charge card. He has been employed by the same firm for ten years, has no Judgements against him, has never been in trouble and has never filed for bankruptcy. Best of all, he has NEVER missed a payment or been late on any payment in his entire life. Based on the timeworn and logical assumption that “The best predictor of future behavior is past behavior,” one would assume that Joe is a very low risk borrower, and that he would have a nearly perfect FICO score, right?
Well, not exactly. Institutions or individuals that lend money don't do it out of the goodness of their hearts, they do it to make money. The safer the investment, the less risk involved. But the riskier the investment, the more interest they can charge to mitigate that risk. Thus we see that your FICO score is a simply a “risk assessor”, and this is the point where greed enters the equation. Instead of starting at zero and adding pluses together, these scores start at some magical level of perfectness, then subtract all the possible negatives to come up with a much lower final score. The more negatives, the higher the interest rate; the goal then, is to come up with as many negatives as possible, increasing the perception of risk and providing a somewhat shaky rationale for charging a higher interest rate.
Please note that each of the Big Three credit agencies, as well as others, all have different algorithms with identical goals. Some may dock you for having too much credit, another for too little, so I'll just give a few examples from the Big Three which frequently contradict each other. Joe's credit may be lowered because he has too many credit cards, or too many credit cards that carry a balance, or individual card balances that are more than 15% of the credit limit, or an unspecified cumulative limit that is considered to be too high. He may be docked for the length of time since credit was applied for. Too short? Bad. Too long, or not enough credit? Bad. Too many inquiries? Bad. Now, here is the way consumers get hit with this one: Walk into a car dealership in which they convince you to finance with them, promising the lowest interest rate. The dealer “shotguns” your info to a half dozen sources and your credit takes a hit for “too many inquiries”. No cars financed? That's a lack of recent installment loan information---bad. (Maybe he can't afford one.) Joe is taking a lot of negative hits here, especially given his stellar history, but there's more.
Fico scores are set up for a limited population--- people who live from paycheck to paycheck. Take away the paycheck and you end up homeless or in the modern version of debtor's prison. Have you noticed that credit cards, store cards and all sort of credit applications ask only about your income and your bills? With the exception of mortgage applications that require you to sign over your oldest child, no one cares about your assets. Take Joe, for example, when his Aunt Tilley died she left her favorite nephew a cool $100,000. Joe took that money and put most of it into a college fund for his kids. With the rest, he went out and bought that bass boat. Nobody cares.
As Bernie Sanders is fond of saying, “The system is rigged.” The only recourse we have is to understand the system, then try to game it.