Understanding your FICO Score

A good credit score can help you obtain a loan at a more favorable rate. But that information doesn’t do you any good if you don’t know how to build a solid credit score and better yet how to keep that score. Let’s explore the most widely used credit scoring model — the FICO score — and how your FICO score is calculated.

What a credit score is, and why you need one

A credit score is a three-digit number that reflects a person’s creditworthiness and how much of a risk you are to Lenders. It is made up of a number of factors, including payment history, amounts owed, length of credit history, types of credit and new credit. This information is used by lenders to figure out whether or not you are likely to pay back your debts. The factors that make up your score are taken directly from your credit report, which contains the raw data of how you use your credit.

If you plan to borrow money for any reason in the future to buy a car or to take out a mortgage, it’s a good idea to establish and maintain a good credit score. You will need an established credit history in order to borrow money, rent an apartment, or avoid paying deposits on utilities and more.

If you don’t have a credit score yet, we’ll be publishing a post on building one from scratch.

What you need to know about your FICO score

FICO, or Fair Isaac Corp., is the industry leader in credit scoring. Its credit score — the FICO score — is used by more than 90% of lenders. Your score will range from 300 to 850, the higher the better. It is calculated as follows:

Payment history (35%): Do you make your payments on time? Do you have any negative public records, such as bankruptcies, foreclosures, liens, lawsuits, etc.?

When you make a late payment, your credit score will take a hit. How much? That depends. The FICO score takes into consideration how late the payment is, how much was owed, how recently the late payment occurred and how many late payments you’ve made. Generally, payments late by only a few days will not be reported (but you will likely incur a late-payment penalty from your card issuer, so always make your payments on time).

Credit utilization (30%): How much do you owe on all of your accounts? How much do you owe on specific types of accounts, such as credit cards? How much do you owe in proportion to how much credit you have?

In general, the more debt you carry in relation to your credit limit, the lower your score will be. Balances are often reported mid-billing cycle, so pay attention to your utilization at all times, not just after you’ve made your monthly payment.

Length of credit history (15%): How long ago did you open your first credit account? What about your newest credit account? What is the average length of all of your credit accounts?

As a rule, people with longer credit histories will have better credit scores than those with short credit histories. However, taking this into account, the FICO score reallocates the importance of each of these five categories depending on your particular overall credit picture. So those with short credit histories can still have good credit scores.

Types of credit in use (10%): What types of credit accounts do you have? Do you only have one type of account, like credit cards?

How many and what variety of accounts you have will have an effect on your credit score, but not much of one. The truth is, it’s hard to estimate exactly what impact this will have, because how many accounts is too many really depends on your overall credit picture. Also, if you recently closed accounts and think they are gone forever, think again. Their histories will still affect this part of your FICO score.

New credit (10%): Have you applied for new credit recently? Did you apply for multiple new credit accounts in a short period of time? How many hard inquiries have you had in the last year?

As a general rule, it’s not wise to apply for multiple credit accounts in a short period of time, especially if you have a short credit history. One additional inquiry may have little or no effect on your credit score, but applying for a lot of new credit will affect the average length of your credit accounts, which can lower your credit score.

While credit inquiries sit on your credit report for two years, they affect your FICO score for only 12 months.

The calculation we’ve described is known as an algorithm, or the formula that translates the raw data from your credit report into a numerical score. FICO has its own algorithm, but there are other algorithms used for free and/or proprietary scores. Because FICO is the most widely used scoring model, you shouldn’t rely on free and non-FICO scores for an accurate snapshot of your creditworthiness. They’re likely a good indication of your credit health, but your lenders are probably not looking at these scores.

Where the credit reporting bureaus come in

You now know what a FICO score is, but did you know that you could possibly have three different FICO scores? Each of the three major credit reporting bureaus — TransUnion, Equifax and Experian — generates its own score by using the FICO algorithm in relation to its credit data. Unless one of the bureaus has a major error or discrepancy on your credit report, these scores should all be relatively similar.

When you apply for credit, the lender will pull one, two or all three of the credit bureaus’ scores. Generally, for something big like a mortgage, all three scores will be pulled, whereas a credit card issuer may pull only one score.

How to get your FICO score

You can obtain your FICO score and more through myFICO, the company’s consumer division. You’ll be able to purchase one-time scores and reports, or ongoing scores and reports. If you choose the ongoing option, you can cancel at any time with a phone call.

You can also obtain your scores from any of the three credit reporting bureaus, TransUnion, Equifax and Experian, at a price. Pay attention to the type of score you’re buying, you’ll want to purchase FICO scores, not proprietary scores.

Thanks to Wall Street reforms, you are able to get your FICO score for free if you are denied a loan or insurance because of it. The reforms are meant to make borrowing practices safer and more transparent for citizens, to crack down on abusive lender practices and to ban unfair rate hikes on credit cards.

For the credit score most likely used by potential lenders, you’ll want to obtain your FICO score from one, two or all three of the major credit reporting bureaus. Understand what makes up your FICO score and practice good credit habits to build up an excellent score. To monitor your credit building efforts, check if one of your lenders offers a free FICO score or purchase your scores from the bureaus.

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