Updated: Sep 19, 2024

There are two separate acronyms, FICA and FICO, that are often confused. FICA stands for Federal Insurance Contribution Act, and it has nothing to do with lending. FICO stands for Fair, Isaac and Company, and this is the score lenders consider when they look into your credit history. When you apply for a home equity loan, your FICO score will be used.

Background

A FICO score is a credit score. In the U.S. today, there are three agencies in charge of tracking these scores. They are self-regulating, and they track scores solely through lender participation. When you take out a new loan, the lender reports the loan to the three agencies, and they do the work of tracking the loan over time. If you miss payments, default or refinance your debt, it is up to the lender to report this activity as well. In the end, the agencies compile all of this information, and they come up with a FICO score based on a mathematical formula. The scores from each agency–TransUnion, Equifax and Experian–should be similar for a particular individual.

Function

Lenders report your payment history as a way of helping themselves out in the future. They would like to know which borrowers repay debts and which do not. The only way to know this is to ask other lenders about their experience with a given borrower. The credit reporting system allows this to occur. As soon as you are born, your credit history begins. No information will appear until you take out your first loan, but from that day forward, your score will affect your ability to get new loans.

Significance

When it comes to taking out a home equity loan, your FICO score will certainly matter. The lender will want to know how you have performed on debts in the past. If you have taken on a large number of debts and paid on time, you will have a high score, and the lender will extend you a loan at the best possible interest rate. If you are somewhere in the middle, perhaps having missed payments in the past or lacking a loan history, the lender may extend you a loan but charge you more. If you are on the bottom, meaning you have defaulted in the past or gone through bankruptcy, you will have difficulty finding a home equity loan.

Considerations

A home equity loan is a secured loan, meaning it uses your current home as collateral. Obtaining a secured loan is often easier than obtaining a loan without collateral. As a result, even an individual with moderate to poor credit may be able to take out a home equity loan. As long as you have equity in your current house, you will likely find a lender willing to work with you. However, it is important to consider financing fees before taking on the debt. You will be penalized for your poor credit, and the resulting fees can make the loan unattractive.

Risks

Aside from financing fees, home equity loans are risky because you are putting your home on the line. Many borrowers make the mistake of thinking they cannot go into foreclosure as long as their primary mortgage is in good standing. On the contrary, your home equity lender can foreclose on your property. The lender has the option of buying your primary mortgage and forcing you into foreclosure as a result. If you have a low FICO score, be wary of entering into home equity loan contracts. The high cost and the risk of losing your home can make the deal a bad one for you and a good one for the lender.