Why are Credit Scores so important?

If you're like me than you've lived your life without too much concern over some arbitrary number called your FICO score. Then one day when you're trying to convince somebody with money to lend you that money, you realize the importance of this number. In the old days, people lived in smaller communities and in general people were closer. Lending decisions were based on family connections and your standing in the community. In todays world, the money you want to borrow can come from a little old lady in China or an underworld figure in Russia. Now while this greatly increases the funds available for you to buy a car, a home, or fund a business, lenders need a uniform way of measuring risk. Because lets face it, the primary concern for any lender whether you're seven years old lending your classmate a comic book or about to retire and wondering what to do with your nest egg; you want to know you're going to get your asset returned. This is where the Credit score comes in. Yes, there are other factors but credit scores are paramount.

The current problems in the credit market should highlight the importance of credit scores. We've all heard the problems caused by "sub-prime" mortgages. In layman's terms, people with poor credit scores received funding they otherwise would not be eligible for because their credit scores indicated a high risk of default. Lenders ignored those scores, made those loans, and then repackaged and sold them to Wall Street. What do you think happened? Those people with poor scores did in fact default on those loans and now pension funds, investment banks, and hedge funds own mortgage paper nobody wants to buy without steep discounts. Trust me on this, financial institutions are inherently risk adverse and they've been burned badly on this. They wont be burned again. Credit scores will not be ignored again.

I've always felt credit score maintenance should be taught to children at an early age. It's basic principals are used in everyday social interactions. All it really is using your history of behavior as a guide for future behavior. Can anybody change their behavior? Sure but the likelihood that past actions guide future ones is well established. My son is in kindergarten and he has a classmate that constantly breaks crayons. He has "bad credit" when it comes to crayons with the entire class. What is the likelihood anybody in that class will lend him a crayon? In todays world, the risk premium would be astronomical. My five year old son understands this. He knows that kid cannot pay the premium (which would be at least another crayon) so refuses to lend him a crayon.

You may find the credit score a cold mechanism to define the various wonderful aspects of you but as imperfect as it can be, until something else is invented, it is needed so money can flow. It is unfortunate people are uneducated about the maintenance of their credit score until significant damage has been done. Get educated.