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FICO 101

Do you know what your FICO credit score is?

Are you asking, “What is a credit score”?

Well, you had better get with the times if you don’t! Credit scores are used for everything from mortgages, loans, auto insurance, ordering utilities, buying cell phone service, renting an apartment, and even applying for a job, so here is a crash course – FICO 101.

Your credit score can be clinically defined as “a numerical expression, based on a statistical analysis of a person’s credit files,” used as tool “to represent the creditworthiness of person.” (So says Wikipedia.) The three major credits bureau each have their own formula for computing the scores, and they use competing scoring systems.

Your current creditors use this score to determine whether to increase your credit line – or charge you a higher interest rate. New lenders use this score to determine whether to approve a car loan or a mortgage loan and, if approved, what interest rate to charge, and the amount for which you should be approved. The higher the number, the better you look to lenders. People with the highest scores get the lowest interest rates.

MR: Mine use to be over 800, but I haven’t check in the last few years.

Just what goes into calculating the score? Everything in your credit report, with different kinds of information carrying differing weights, says Fair Isaac Corp. (FICO) Public Affairs Manager Craig Watts. The FICO scoring model looks at more than 20 factors in five categories.

1. Paying your bills (35% of the score) The most important factor is how you’ve paid your bills in the past, placing the most emphasis on recent activity. Paying all of your bills on time is good. Paying them late, on a consistent basis, is bad. Having accounts that were sent to collections is worse. Declaring bankruptcy is worst.

2. Amount of money you owe and the amount of available credit (30%)
The second most important area is your outstanding debt – how much money you owe on credit cards, car loans, mortgages, home equity lines, etc. The total amount of credit you have available is also considered. Statistics have shown that people who have a lot of available credit tend to use it, which makes them a less attractive credit risk.

“Carrying a lot of debt doesn’t necessarily mean you’ll have a lower score,” Watts says. “It doesn’t hurt as much as carrying close to the maximum. People who consistently max out their balances are perceived as riskier. People with the highest scores use credit sparingly and keep their balances low.”

3. Length of credit history (15%)
The third factor is the length of your credit history. The longer you’ve had credit, especially with the same credit issuers, the more points you get.

4. Mix of credit (10%)
The best scores will have a mix of both revolving credit (such as credit cards) and installment credit (such as mortgages and car loans). “Statistically, consumers with a richer variety of experiences are better credit risks,” Watts says. “They know how to handle money.”

5. New credit applications (10%)
The final category is your interest in new credit and how often you are applying. The model compensates for people who are “shopping” for the best mortgage or car loan rates. The only time shopping really hurts your score, Watts says, is when you have recent credit stumbles, such as late payments, or bills sent to collections.

What doesn’t count in a score

The scoring model doesn’t look at things such as age, race, gender, job or length of employment, income, education, marital status, length of time at your current address, whether you rent or own, and other information not contained in your credit report.
With that being said…these variables may not be factors in determining your FICO credit score, but lenders may consider all of those factors when deciding whether to approve a loan application.

Credit scores are not perfect

The major drawback to credit scoring is that it relies on information in your credit report, which is quite likely to contain errors. Checking your credit report annually can help alleviate some inevitable mistakes. If you plan to buy a house or a car, look at your credit report at least six months beforehand, to correct any mistakes on your report that may lower your credit score.

Recently enacted laws enable you to obtain a free credit report annually from each of the three bureaus. However, these days, it may be beneficial to belong to a service that enables you to check your credit report and FICO scores at any time. Not all creditors report data to all bureaus, or report it correctly. You have no control over which bureau a new creditor will use to determine whether to offer you more credit. Many services allow you to see your comparative reports with the scores.

In addition, with new credit requirements imposed after the bank bailouts and credit card reforms, banks are quicker to take actions that can lower your score. For example, they may lower your credit limit. This impacts your debt-to-credit ratio, and makes it seem like you are using more of your limit. They are also requiring higher score to get the best rates. More careful monitoring is necessary to keep up with this.

You have the right to know your FICO credit score at any time. Keep up with it, since this score is more important in your everyday life than you may realize!

This guest post was brought to you by CareOne Credit – they are Certified Credit Advisors. Check them out for any questions you may have on your credit!”?

12 Responses to FICO 101

  1. Great post. I didn’t know what the components of the credit score were until today!

    My score is still getting hit from an account from ages ago. I thought it was closed, but they had that it was still open and that I owed 50 dollars. I need to take care of that…

    • I didn’t know either… I guess I just never thought to look for the components! It’s a learning experience for me too today 🙂

  2. Good explanation! FICO scores are a little bit of a mystery to most people. I would add that even if your score is good (700+), take care of any black marks. That will come back and bite you!

    • Great advice! I recently found out a bill that got lost and was sent to a collections agency. I call and got it cleared up though (I think)… Perhaps I’ll get a free credit report, just to make sure!

  3. Good explanation! One mistake people do is getting focussed on a number rather than a range.

    If you are applying for credit do you think it matters if you have 760 or 790? Most agencies look at range, not absolute value.

  4. Cool post. I have never really looked at the breakdown of my credit scores. It has always made me crazy trying to figure out my score. When we were buying our house the mortgage lender basically told me to pay off the debt and that would take care of most of my score. It did:)

    • Good question! I don’t know if it gets negatively impacted or not.

      In fact since you are more capable of making debt payment, I wouldn’t be surprised if your score goes up. Especially since it’s based on history, and if you successfully paid off a large debt amount like a mortgage, I think that would say that one is a good risk.

  5. As it pertains to mortgages, I had a mortgage on a rental prop that was paid off, I noticed a slight uptick in my score. It certainly lowers the debt you carry and thus affects the 30% bucket. in terms of a LOC/HELOC, that would be a credit line available, but if you don’t use it (or as much), I would think it also increases FICO based on the buckets and calcs within each

  6. Having a good Fico score is a must especially if you are buying ticket items like cars and homes. It affects your purchasing power. People with low fico score will pay more in the long run in terms of getting higher interest rate. In terms of car, people with good scores can walk away with no down payment and lower monthly payments.

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