What Determines A FICO Score

When you hear the term “credit score”, it usually refers to your FICO score. The calculations made to arrive at this score were developed by the Fair Isaac Corporation, hence the name “FICO”.

Any time a consumer applies for a mortgage, car loan, or any other type of credit card or loan, the FICO score is almost universally used to determine a person’s creditworthiness. This score gives potential lenders a basis from which they can decide if an applicant is likely to pay back the loan in a timely fashion or is more apt to default on the loan. It also serves as a guideline as to how much a consumer will be able to borrow and the overall terms of the loan agreement, such as length of the loan and interest rates.

Scores are formulated using a scale from 300 to 850. All three major credit bureaus, Experian, Equifax and Transunion, use these formulations, perhaps with some slight variations. This accounts for the sometime different scores reported for the same consumer by the 3 different companies. Normally, the scores only differ slightly. If there is a big discrepancy in the scores, it may be a sign of incorrect information being listed and should be reported and investigated.

In simple terms, usually the higher your FICO score, the more creditworthy you will be deemed by lenders. This translates to being able to borrow more money (either as a mortgage, loan, or actual cash) and paying lower interest rates. In the case of a mortgage or car loan, lower interest rates can save you thousands of dollars over the life of your loan.

While the actual formula to determine a FICO score is not public knowledge, the following calculations are generally thought to be used to arrive at the score.

35% of your score is derived from your credit history. Creditors report to the credit agencies every month about your payment history. Are bills paid on time? Have you taken a bankruptcy? Even things as common as library fines and parking tickets can show up on your report. Outstanding medical bills can be included, also.

30% of your score is determined by the total amount you owe to your creditors compared with your total available credit or original amount borrowed. If all of your credit cards are at their available limits, this can seriously hurt your credit score.

Your credit history accounts for 15% of your score. This means how long you have had an active account and if your payments have been made in a timely manner during this period. The ideal situation is to have fewer accounts and have them be older, and of course, to always have been punctual with payments.

Another 10% of your score is calculated by how many new accounts you have recently opened as compared to your older accounts and also how many inquiries you have into your credit history. Each time you apply for any type of credit, it shows up as an inquiry. If a creditor checks your score and sees an unusually high number of inquiries, it can trigger an alarm that you are seeking different sources of new credit and perhaps are in financial trouble. Be very selective when applying for any new credit.

The final 10% of your score comes from the different types of credit used. Mortgages and other long-term loans indicate your ability to manage a large loan with a fixed monthly payment. Credit card debt is weighed more heavily since it is considered revolving debt- that is, the amount you owe and the amount you pay can fluctuate from month to month. Someone who pays off the entire balance each month is considered more desirable than someone who just pays the minimum amount.

To get the best rates on a credit card or loan, a score of 700 will be needed, at the least. This number is achieved when all of your payments are on time and you use your credit cards wisely. Most experts agree that the lower your outstanding credit card balances, the better. Most suggest using only 1/3 of the total credit available and paying off the entire balance each month.

A credit score below 620 is considered “subprime” and indicates the consumer is a poor credit risk. If credit is extended, it normally comes with very high interest rates and undesirable terms.

It’s a good idea to get a copy of your credit report from all three credit bureaus and go over them to check for inaccuracies. By law, you are entitled to one free report from each agency once a year. If you are ever denied credit, the creditor must notify you in writing and inform you which agency they used to obtain your credit history. You can then get a free report based on the denial.

To learn the answers to some of the most common credit questions, click on Credit FAQs.