What Is a FICO Score and Why Does It Matter? by Tim Mock

What Is a FICO Score and Why Does It Matter?

Tim Mock

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Your FICO score plays a crucial role in determining your access to credit and the terms you'll receive. This three-digit number, typically ranging from 300 to 850, serves to summarize your creditworthiness in a way that makes your score the primary determining factor for most lenders.

Let's dive into what FICO scores are, why they matter, and how you can improve your score.

What is a FICO Score?

FICO is short for the Fair Isaac Corporation, which introduced its credit scoring model in 1989. This score is calculated using credit report data from the three major credit bureaus:

Equifax

Experian, and

TransUnion.

Although FICO isn't the only credit scoring model—VantageScore is a notable competitor—it's the most widely used and most well-known model among today's lenders.

Why Your FICO Score Matters

Your FICO score can influence:

Loan approvals

Interest rates on credit cards and loans

Rental approvals

Insurance premiums

Employment opportunities in some fields

What's Considered a Good FICO Score?

FICO scores typically fall into the following ranges:

Exceptional: 800-850

Very Good: 740-799

Good: 670-739

Fair: 580-669

Poor: 300-579

While FICO considers 670-739 "good," each lender sets its own criteria for what it considers a good score. Additionally, lenders usually consider the number and type of credit lines that make up your score when determining creditworthiness.

For instance, a 700 credit score based on over a decade of history involving mortgages, car loans, and credit cards is viewed much more favorably than a 700 credit score coming from a person having no history except six months of on-time payments for a credit card.

Factors That Influence Your FICO Score

FICO calculates your score based on five primary factors:

Payment History (35%): Consistently paying bills on time is crucial.

Amounts Owed (30%): This includes your credit utilization ratio. Aim to use less than 30% of your available credit.

Length of Credit History (15%): Longer credit histories significantly improve your score.

Credit Mix (10%): Having a variety of credit types, such as credit cards, car loans, and mortgages, can positively impact your score.

New Credit (10%): Opening several new accounts in a short period can lower your score temporarily.

Why Are My FICO Scores Different?

You don't have just one FICO score. There are multiple versions of the FICO scoring model, so your score can vary depending on which source you count on.

Additionally, scores can vary widely depending on whether a hard or soft pull is used. For instance, Credit Karma and credit card statements rely on soft pull data, so their scores vary significantly from hard inquiries coming directly from credit agencies.

Scores can vary depending on which credit bureau's data is used. There are also industry-specific FICO scores that can cause further variation.

Strategies for Improving Your FICO Score

Building a good credit score takes time, but there are several strategies you can employ to improve your FICO score:

Set up automatic payments to ensure bills are paid on time.

Keep credit card balances below a utilization rate of 30 percent.

Avoid shortening your credit history by closing old credit accounts.

Limit new credit applications to avoid multiple hard inquiries.

Consider becoming an authorized user on a family member's well-managed credit card.

Use a secured credit card to build credit if you're new to credit or rebuilding your score.

Dispute any inaccuracies you find in your credit report.

Accessing Your FICO Score

Many credit card issuers now provide free FICO scores relying on soft-pull data to their customers. These free scores provide an estimate, but they vary from the exact score lenders will rely on when determining your creditworthiness.

To get a precise score, you can also purchase your scores directly from credit bureaus. However, under the Fair Credit Reporting Act, you are also entitled to receive a free copy of your credit reports from all three major credit bureaus every year.

Most Common FICO Scoring Models

FICO regularly updates its scoring models to reflect changing technology, consumer behaviors, and economic conditions. Although FICO 8 remains the most widely used version, newer versions, like FICO 9, FICO 10, and FICO 10T, introduce refinements that can impact how your creditworthiness is assessed.

FICO 9

First introduced in 2014, FICO 9 brought several changes:

• Paid collections are no longer factored into the score

• Medical collections have less impact on the score

• Rental history is considered when reported

These changes aim to provide a more nuanced view of a consumer's credit risk, particularly for those with medical debt or a history of rental payments.

FICO 10 and 10T

Released in 2020, FICO 10 and 10T represent the latest evolution in credit scoring:

• FICO 10 places more emphasis on recent credit behavior

• FICO 10T (T for "trended data") looks at account balances and payment amounts over the past 24 months

These newer models aim to provide a more dynamic picture of your credit management habits over time. Overall, they have the potential to reward people who consistently pay down debt and penalize those who accumulate more debt.

Industry-Specific FICO Scores

Generate FICO scores are widely accepted, and they give consumers the best-possible picture of their credit worthiness. However, FICO also produces industry-specific scores tailored toward particular types of lending:

FICO Auto Score: Designed for auto lenders, this score emphasizes past auto loan payment history.

FICO Bankcard Score: Used by credit card issuers, this score focuses on credit card payment behavior.

FICO Mortgage Score: Tailored for mortgage lenders, this score gives extra weight to mortgage payment history.

These specialized scores range from 250 to 900 and provide lenders with more targeted risk assessments for specific types of credit products.

Impact of Credit Inquiries on Your FICO Score

Although new credit applications account for only 10% of your FICO score, understanding how inquiries affect your score can help you manage credit more wisely:

Hard inquiries occur when you apply for credit. Every inquiry can lower your score by a few points and remain on your credit report for two years.

Soft inquiries, such as when you check your own credit or when a lender pre-approves you for an offer, do not affect your score.

FICO's rate-shopping provision allows multiple inquiries for the same type of loan, such as a mortgage or auto loan, within a short period (typically 14-45 days) to count as a single inquiry.

The Future of Credit Scoring

As technology advances and more data becomes available, credit scoring models are likely to evolve further. Changes to credit scoring systems likely to emerge in the near future include:

• Increased use of alternative data, such as utility bills, banking history, and rental payments

• Integration of AI and machine learning

• Greater emphasis on recent data to provide more current assessments of creditworthiness

Understanding Your FICO Score

Knowing the significance of FICO scores and the factors that influence them sets you on the road to making good financial decisions. Through good credit habits, you can work toward a strong FICO score that opens doors to better interest rates and more opportunities.

Remember, building good credit takes time and consistency. Stay patient, keep monitoring your progress, and celebrate the small wins as you work towards your financial goals.

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Posted Jun 27, 2024

Your FICO score summarizes creditworthiness for determining loan approvals and rates. Find out why this score is widely used by lenders.

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