What is the FICO Score?
A FICO score is a type of credit score created by the Fair Isaac Corporation. Lenders use borrowers’ FICO scores along with other details on borrower’s credit reports to assess credit risk and determine whether to extend credit. FICO scores take into account various factors in five areas to determine credit worthiness: payment history, current level of indebtedness, types of credit used, length of credit history and new credit accounts.
Breaking Down FICO Score
FICO scores range between 300 and 850. In general, scores above 740 indicate a very good credit history. In contrast, individuals with scores below 620 often find it difficult to obtain financing at favorable rates. To determine credit worthiness, lenders take a borrower’s FICO score into account but also consider other details such as income, how long the borrower has been at his job and type of credit requested.
Calculating FICO Scores
To determine credit scores, the Fair Isaac Corporation weighs each category differently for each individual. However, in general, payment history is 35% of the score, accounts owed is 30%, length of credit history is 15%, new credit is 10% and credit mix is 10%.
Payment history refers to whether an individual pays his credit accounts on time. Credit reports show the payments submitted for each line of credit, and the reports indicate if the payments were received 30, 60, 90, 120 or more days late.
Accounts owed refers to the amount of money an individual owes. Having a lot of debt does not necessarily equate to low credit scores. Rather, FICO considers the ratio of money owed to the amount of credit available. To illustrate, an individual who owes $10,000 but has all of his lines of credit fully extended and all of his credit cards maxed out may have a lower credit score than an individual who owes $100,000 but is not close to the limit on any of his accounts.
Length of Credit History
As a general rule of thumb, the longer an individual has had credit, the better his score. However, with favorable scores in the other categories, even someone with a short credit history can have a good score. FICO scores take into account how long the oldest account has been open, the age of the newest account and the overall average.
Types of Credit
Credit mix is the variety of accounts. To obtain high credit scores, individuals need a strong mix of retail accounts, credit cards, installment loans such as signature loans or vehicle loans, and mortgages.
New credit refers to recently opened accounts. If the borrower has opened a bunch of new accounts in a short period of time, that indicates risk and lowers his score.