What Is a FICO?
When it comes to credit scores (also generically referred to as a credit rating), most Americans know that they are important and that they can have a major impact on our financial lives. However, very few know what goes into a credit score or just how influential it can be.
First of all, the term, “credit score” does NOT refer to a SINGLE scoring system. In the US, there are over a thousand credit scoring models in existence, created and used by hundreds of creditors and consumer reporting agencies. However, the most common credit scoring model (used in about 80% of all credit-based decisions) was developed by Fair Isaac Corporation (FICO for short).
Founded back in 1956 by Bill Fair and Earl Isaac, FICO manages products that help creditors to predict the rate at which an individual will default on a loan. An individual’s FICO score does not determine how much money he or she may borrow.
Rather, it provides a numeric rating of the risk to the creditor that the borrower is. The score ranges from 300 (extreme risk) to 850 (very low risk). Consider that most consumers with scores below 750 will end up paying higher interest rates than those who have worked to keep their scores above 750.
The score is based solely upon the information included in the individual’s credit report.
The five most important factors in a FICO score are as follows:
1. Payment History: This section considers your pattern of on-time and/or late payments. The more recent the activity the more influential the activity is, i.e. a pattern of recent on-time payments is more influential than late payments from 5 years ago.
2. Balance-to-Limit Ratio: This section compares your current debt balances to your potential debt (total credit limit) at a card-by-card and an aggregate level. This is also called “Usage.”
3. Length of Credit: This section considers how old the accounts are that are listed on your report, both on an individual level and overall average. You may consider closing a credit account from time to time. Be aware that closing any card that helps to establish your length of credit history may lower your credit score.
4. Pursuit of New Credit (Inquiries): This portion considers how much new credit you have recently applied for. If you apply for more than a couple lines of credit each year, the credit scoring model essentially wonders why you’re needing so much credit.
5. Credit Mix (Types of Credit): This section takes into consideration the variety of credit lines you have opened and/or used recently, including credit cards, retail store cards, mortgage loans, auto and other installment loans, consumer finance accounts, etc. Some variation in credit is preferred.
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