What is a Credit FICO Score and
How It's Calculated
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Learn what
a
credit FICO score
is, how it's calculated,
what it means, and
why it's important.
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The Almighty FICO
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A credit score, commonly known as FICO scores, are
used by creditors to determine how good a credit
risk you are. It has predictive value for telling
the lender how likely you are to repay a loan or to
make payments on time.
The credit score is calculated using information
in your credit reports. Usually each person living
in the United States who has a Social Security
number, whether a citizen or not, will have three
versions of credit reports to their name. Equifax,
Experian and Trans Union are the three main credit
bureaus who collect your credit information and
provide your credit report (also known as credit
profile) to your lenders/creditors. |
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How is a Credit Score (FICO)
calculated?
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Credit scoring is a method of evaluating an
applicants creditworthiness by assigning values to
such factors as income, existing debts, and credit
references, etc. It takes inputs from your credit
report and your credit application and generates a
score (number) based on statistical models.
Different lenders may use different methods for
calculating scores; therefore, scores differ from
lender to lender depending on the type of financial
service you are seeking.
The most popular credit score is FICO score. Fair
Isaac & Company developed a score, called a FICO
score, to estimate the likelihood that you will
repay the loan. FICO summarizes your credit history
into a single number. There are really three FICO
scores computed by data provided by each of the
three credit reporting agencies - Experian, Trans
Union and Equifax. FICO scores range between 300 and
850. The classification for bad credit varies from
one credit extending institution to another.
Generally, the acceptable score for first tier
credit institutions is 660. However, there are many
credit extending institutions that accept scores
down to 560. Below this you may have to seek help
from bad credit extending institutions.
Everyone with a credit record also has a credit
score. Different lenders and other companies may use
different scoring systems, so your score (and the
products or services you're offered as a result) may
vary significantly from one source to another. |
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Five Main Information Categories
on a Credit Report
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Described below are the five main categories of
information on your credit report which are used in
the calculation of your credit score, along with
their general level of importance. Within these
categories is a complete list of the information
that goes into a FICO score. Be aware that:
- A score takes into consideration all these
categories of information, not just one or two.
No one piece of information or factor will
determine your score.
- The importance of any factor depends on the
overall information in your credit report. For
some people, a given factor may be more
important than for someone else with a different
credit history. In addition, as the information
in your credit report changes, so does the
importance given any one factor in determining
your score. Because the details of your
financial situation are unique, and the exact
formula used in calculation of your credit score
is kept secret, it is not possible to predict
what factors will bear the most weight in your
situation. Thus, it's impossible to say exactly
how important any single factor is in
determining your score - even the levels of
importance shown are for the general population,
and will be slightly different for different
credit profiles. What's important is the mix of
information, which varies from person to person,
and for any one person over time.
- Your score only looks at information in your
credit report. Lenders look at many things when
making a credit decision, including your income
and the kind of credit you are applying for.
However, your FICO score does not reflect these
facts, as it only evaluates your credit report
at the credit reporting agency.
- Your score considers both positive and
negative information in your credit report. Late
payments will lower your score, but having a
good record of making payments on time will
raise your score.
- Your score does not consider your ethnic
group, religion, gender, marital status and
nationality. These are, in fact, prohibited from
use in scoring by US law.
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Top Five Things that Really Count
on Your Credit Report
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1) Payment History: Approximately
35% of your score is based on your Payment History
The first thing any lender would want to know is
whether you have paid past credit accounts on time.
This is also one of the most important factors in a
credit score. However, late payments are not an
automatic "score-killer." An overall good credit
picture can outweigh one or two instances of, say,
late credit card payments. By the same token, having
no late payments in your credit report doesn't mean
you will get a "perfect score." Some 60-65% of
credit reports show no late payments at all - your
payment history is just one piece of information
used in calculating your score.
Your credit score takes into
account:
- Payment information on many types of
accounts. These will include credit cards (such
as Visa, MasterCard, American Express and
Discover), retail accounts (credit from stores
where you do business, such as department store
credit cards), installment loans (loans where
you make regular payments, such as car loans),
finance company accounts and mortgage loans.
- Public record and collection items - reports
of events such as bankruptcies, judgments,
suits, liens, wage attachments and collection
items. These are considered quite serious,
although older items will count less than more
recent ones.
- Details on late or missed payments and
public record and collection items -
specifically, how late they were, how much was
owed, how recently they occurred and how many
there are. A 30-day late payment is not as risky
as a 90-day late payment, in and of itself. But
recent payments and frequency count too. A
30-day late payment made just a month ago will
count more than a 90-day late payment from five
years ago. Note that closing an account on which
you had previously missed a payment does not
make the late payment disappear from your credit
report.
- How many accounts show no late payments. A
good track record on most of your credit
accounts will increase your credit score.
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2) Amounts Owed:
About 30% of your score is based on Amounts Owed.
Having credit accounts and owing money on them
does not mean you are a high-risk borrower with a
low score. However, owing a great deal of money on
many accounts can indicate that a person is
overextended, and is more likely to make some
payments late or not at all. Part of the science of
scoring is determining how much is too much for a
given credit profile.
Your credit score takes into
account:
- The amount owed on all accounts. Note that
even if you pay off your credit cards in full
every month, your credit report may show a
balance on those cards. The total balance on
your last statement is generally the amount that
will show in your credit report.
- The amount owed on all accounts, and on
different types of accounts. In addition to the
overall amount you owe, the score considers the
amount you owe on specific types of accounts,
such as credit cards and installment loans.
- Whether you are showing a balance on certain
types of accounts. In some cases, having a very
small balance without missing a payment shows
that you have managed credit responsibly, and
may be slightly better than no balance at all.
On the other hand, closing unused credit
accounts that show zero balances and that are in
good standing will not generally raise your
score.
- How many accounts have balances. A large
number can indicate higher risk of
over-extension.
- How much of the total credit line is being
used on credit cards and other "revolving
credit" accounts. Someone closer to "maxing out"
on many credit cards may have trouble making
payments in the future.
- How much of installment loan accounts is
still owed, compared with the original loan
amounts. For example, if you borrowed $10,000 to
buy a car and you have paid back $2,000, you owe
(with interest) more than 80% of the original
loan. Paying down installment loans is a good
sign that you are able and willing to manage and
repay debt.
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3) Length of Credit History: About
15% of your score is based on Length of Credit
History
In general, a longer credit history will increase
your score. However, even people with short credit
histories may get high scores, depending on how the
rest of the credit report looks.
Your credit score takes into
account:
- How long your credit accounts have been
established, in general. The score considers
both the age of your oldest account and an
average age of all your accounts.
- How long specific credit accounts have been
established.
- How long it has been since you used certain
accounts.
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4) Are You Taking on More Credit:
About 10% of your score is based on New Accounts
People tend to have more credit today and to shop
for credit - via the Internet and other channels -
more frequently than ever. Fair, Isaac scores
reflect this fact. However, research shows that
opening several credit accounts in a short period of
time does represent greater risk - especially for
people who do not have a long-established credit
history. This also extends to requests for credit,
as indicated by "inquiries" to the credit reporting
agencies - an inquiry is a request by a lender to
get a copy of your credit report.
The scores
distinguish between searching for many new credit
accounts and rate shopping, which is generally not
associated with higher risk. In part, this is
handled by treating a grouping of inquiries - which
probably represents a search for the best rate on a
single loan - as though it was a single inquiry.
Your credit score takes into
account:
- How many new accounts you have. The score
looks at how many new accounts there are by type
of account (for example, how many newly opened
credit cards you have). It also may look at how
many of your accounts are new accounts.
- How long it has been since you opened a new
account. Again, the score looks at this by type
of account.
- How long it has been since you opened a new
account. Again, the score looks at this by type
of account.
- How many recent requests for credit you have
made, as indicated by inquiries to the credit
reporting agencies. Note that if you order your
credit report from a credit reporting agency —
such as to check it for accuracy, which is a
good idea — the score does not count this. This
is considered a "consumer-initiated inquiry,"
not an indication that you are seeking new
credit. Also, the score does not count it when a
lender requests your credit report or score in
order to make you a "pre-approved" credit offer,
or to review your account with them, even though
these inquiries may show up on your credit
report.
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5) Types of Credit in Use: About
10% of your score is based on Types of Credit in Use
According to the information provided by the Fair
& Isaac, the creator of FICO credit score, about 10%
of your credit score is based on:
- What kinds of credit accounts you have, and
how many of each. The score is a complex formula
that takes into account both the types of
account, their mix and the total number of
credit accounts you have under your name.
- Credit account types include: credit cards,
retail accounts, installment loans, finance
company accounts and mortgage loans. In general,
the effect of how many accounts you have and
their mix would vary with your income and other
factors. It is not recommended that you open new
accounts just to "diversify" your credit
profile. This part of the credit score is more
important if you do not have a lot of other
credit information on your file, as would happen
for example to young adults.
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