 What is a FICO Credit Score?
FICO is an acronym for Fair Isaac Credit Organization. It is a
complex method of determining the probability that those
applying for credit will pay their bills. Fair, Isaac began its
trailblazing work with credit scoring in the late 1950s and,
since then, scoring has become commonly accepted by lenders as
a reliable means of evaluating a person’s creditworthiness. The
FICO credit score, which is the most widely used method,
attempts to condense a borrowers credit history into a single
number.
90% of the largest U.S.
banks use FICO® scores
FICO scores range from a low of
300 to a high of 850. A FICO 850 is the numerical
representation of a perfect credit score. According to Fair,
Isaac, approximately 11% of the population has a FICO score
of 800+, with just 1% or so achieving the magic 850
number.
Credit Score
Computations Are Top Secret
If you are planning on reading a book or taking a course to
learn the closely guarded methods Fair Isaac’s uses to compute
credit scores, forget about it. Neither Fair, Isaac & Co.
or the credit bureaus reveal the formulas of how they actually
determine credit scores. Want something else to make you go,
hmmm? Here it is, the Federal Trade Commission has ruled their
secrecy is in no violation of any laws. Having shared that,
here’s the information Fair, Issac & Co does provide us
with, in terms of how they compute credit scores. They weigh
five different categories,
as outlined below
in the pie graph. We’ll provide a very brief description of
each category.
Payment History
As you can see, your payment
history is the most important factor for your FICO score.
Lenders want to know how you've paid your bills in the past,
placing the most emphasis on recent activity. Paying your
bills late on a consistent basis is bad. On time payments
are good. Having accounts sent to collections is worse and
declaring bankruptcy is a MAJOR red flag.
Amounts
Owed
Then after that, the amount of
money you owe which includes two areas. Number one, all of
the: credit cards, car loans, mortgages, personal unsecured
loans, home equity lines, etc) and number two, the amount of
available credit you have access to.
If you have 13 credit cards and
each has a $10,000 credit limit that means you have $130,000
of available credit. Statistically speaking, people with a
lot of credit available tend to use it. Consequently, that
makes them a less attractive credit risk, which will lower
their FICO score. People with the highest FICO scores use
credit sparingly and keep their balances low.
Length of Credit
History
Your length of credit history,
plays another vital part of your FICO credit score. Lenders
look for borrowers with long credit histories. You should be
cautious about opening many accounts in a short span of
time.
New
credit
Approximately ten percent of
your credit score is based on how many new accounts you’ve
recently established. This category reviews: recent requests
for credit report, length of time since credit report
inquiries were made by potential lenders, the number of
accounts and the length of accounts.
Types of
Credit
This category looks at the
overall mix of credit such as: credit cards, car loans,
mortgages, unsecured loans, personal unsecured loans and
home equity lines.
How Do Most People Score
on FICO?
The average FICO score is
usually considered to be around 720. If your FICO score is
less than 600, all most all lenders will pretty much tag you
as a bad credit risk. Meaning, they may extend credit to
you, but the costs are going to be high.
Take a look at the difference in
payments on a 30-year mortgage when the FICO scores goes
from 500 to 850. The rule of thumb is simple:
The
higher your FICO credit score,
the lower your payments
The lower your FICO credit score
the higher your payments
How to purchase a home without a bank
loan.
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