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What is a FICO score, and how does it work?
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The Fair Isaac Corporation (FICO) in 1989 began providing consumers with a type of industry-standard scoring for analyzing creditworthiness. It came to be known as the FICO score. Since then, this FICO score continues to be used by a majority of loan lenders and borrowers for making big financial decisions.
Today, this way of measuring creditworthiness helps people get funds for a new home, a new car, or a big-ticket purchase.
What exactly is a FICO score?
Think of a FICO score as your credit report. The three-digit number, typically in the range of 300 to 850, tells your entire credit history, the available credit to you, the remaining amount of credit on your name, and if you’ve paid all your previous loans on time.
Needless to say, this tool is extremely important for lenders; it helps them gauge money borrowers and make smarter, quicker, and risk-free decisions about where and how much of their money should go.
The good news for the borrower is that since a FICO score is based on credit information, you can improve your credit score over time by paying all your bills on time and not carrying too much debt on your profile.
What is the FICO score range?
A FICO score typically is from 300 to 850. The higher the score, the better the credit. And, better are the chances of quick, smooth loan approval. Loan interest rates too are directly related to credit scores. FICO also has industry-specific ratings for credit cards and auto loans. These can range from 250 to 900 depending on the lender and the type of loan.
Here’s the typical FICO score range:
- Exceptional credit score: 800 to 850
- Very good credit score: 740 to 799
- Good credit score: 670 to 739
- Fair credit score: 580 to 669
- Poor credit score: 300 to 579
What is a good FICO score?
Generally, a score between 670 and 739 is considered good credit. However, every lender or credit card issuer may have different qualifying scores for a particular line of credit.
Keep in mind that a FICO credit score depends on the information in your credit reports. Based on the findings, your score may go up or down. For example, making on-time payments may help in improving your scores, while a late payment could bring down your credit score drastically.
As you can see, your credit scores aren’t static. If you have a fair or bad credit score, you can take steps to improve it over time. Or else, you should be prepared for higher loan rates!
What is a FICO score used for?
Creditors or loan lenders check your FICO scores before deciding whether to approve your loan application or a new credit card or not. Basically, they want to check how you’ve handled your past credit accounts. Apart from the credit scores, lenders or lending companies will also want to check your financial profile, including your income, employment history, and existing debt obligations.
A good FICO score can get you access to the best loan choices and the lowest interest rates. What’s more, most landlords too look at a potential tenant’s score before giving them a final go-ahead. Sometimes, they may check the score to set the amount of the security deposit.
Read more: FICO score to buy a house
What is the importance of a good score?
A FICO score aids people in gaining access to the kind of credit they need. The funds could go toward buying a house, getting an education, or covering medical expenses. Since the scoring is based on a person’s payment history and financial profile, it tells lenders how likely a person is to pay back the borrowed money. It gives them a good idea of what sort of risk is involved in money lending.
Some insurance companies, as well as utility companies, also check the FICO scores at the time of deciding the terms of the service.
More importantly, a good FICO score can help you save good money on interest and loan fees. The reason is that most lenders are willing to give lower interest rates to people with a good score as they are less of credit risk.
A FICO score is overall a fair, quick, and predictive way to ensure that the loan process is efficient and lucrative for both parties involved.
How do you calculate a FICO score?
The FICO scores are calculated by the company by applying a proprietary formula to the data in your credit reports. The resultant scores are based on five credit-influencing factors. These include your payment history, new credit, amounts owed, credit age, and credit mix.
Also, keep in mind that there are three credit bureaus creating your credit reports. These are Equifax, Experian, and TransUnion. All three may have slightly different data from one another – resulting in slight variations in your credit score.
What are the factors affecting a FICO score?
The FICO company doesn’t reveal its proprietary scoring formula. However, it does offer certain guidelines regarding the factors that affect a person’s creditworthiness. Keep in mind that the FICO weighs each category differently for each individual. You need to thoroughly understand these factors and their role in determining the final scores.
In general, the company weighs these parameters as follows:
- Payment history: 35% of the score
- Accounts owed: 30% of the score
- Length of credit history: 15% of the score
- New credit: 10% of the score
- Credit mix: 10% of the score
What can you do to improve your credit score?
- Make sure there are no late payments on your credit report. After all, your payment history makes up a big chunk of your score. A tarnished history can hurt your score the most.
- Ensure that you’re using less debt vis-à-vis your credit limits.
- Make sure the average age of your credit accounts remains less.
- Research the credit card offerings and eligibility requirements for personal finance before applying for one. That’s because any “hard inquiry” when you apply for a loan or a new credit can bring down your score for up to six months.
- Have more than one type of credit in your profile. A good mix of installment loans such as a car loan or a mortgage loan and revolving credit such as a credit card can help your score.
Key takeaways
Fair Isaac Corporation, aka FICO, creates reliable credit scores that many mortgage lenders, credit card issuers, and other creditors use to quantify and evaluate a consumer’s creditworthiness.
These FICO scores are in the range of 300 to 850. The higher the score, the better it is for an individual seeking loans or financial aid.
Also, keep in mind that the FICO score version is updated by the company from time to time. So, you need to keep abreast of any minor changes.
Fortunately, credit repair too is not a static phenomenon. You can take steps to improve it in order to utilize the best loan options as well as get good loan terms and rates.
Read more: What is TRID in real estate?
Written by Ramona Sinha. April 12, 2022
Ramona is a content writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. An avid traveler, she’s a digital nomad at heart and an animal lover from the depths of her soul.
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I thought I already had a little control over loans, and this term is new, what a harder job to understand real estate