Everything you wanted to know about Fico Scores*
*But were afraid to ask
What if I were to tell you that a three-digit number you probably don’t give a moment’s thought to determines your chances of being approved for a credit card, applying for insurance, renting a car or getting a mortgage? Crazy right? Not as crazy as you might think…
The inexorable Fico score
A Fico score is a numeric value somewhere between 300 and 850 that lets potential creditors predict what kind of a risk they’ll be taking if they decide to lend you money. The relationship is inverse – the lower the score, the higher the chances, statistically speaking, that you’ll default on a loan they make you.
As a result, a Fico score doesn’t merely dictate your chances of successfully applying for a loan, but also how much you can borrow and what rate you can borrow it at.
In a nutshell, the higher your Fico score, the more attractive you are to a lender.
When I first started educating myself about credit cards and debt, I did a heck of a lot of reading. I checked out a whole bunch of forums and found it strange that so much of the discussion revolved around building up your credit rating.
‘This is tragic’, I thought to myself, ‘These people are nothing but a bunch of masochistic credit junkies trying to game the system to score one last fix’. I now know that, in fact, I was the tragic one. After doing a little more reading, I came to the stark realisation that the majority of these folks were disciplined, hard-working, and clued in.
Basically, unlike me, they were people who could see the big picture.
They were people who understood that even a 10 point increase in a stupid 3 digit number could mean literally thousands of dollars of savings in the long run. It could mean the difference between them and someone else getting their dream home, not to mention how much it would cost them to insure it. Ultimately, it could mean the difference between happiness and despair.
Indeed, from what I’ve read it seems that most people looking to improve their Fico scores fall into one of two camps
(1) Those who, through poor financial planning or discipline in the past, have ruined their credit rating and are trying to rebuild it, and
(2) Those who have used credit responsibly and virtually always paid their bills off on time and in full, but for one reason or another, have only a mediocre Fico score
What’s interesting about this is that neither group is currently carrying significant, if any, credit card debt. Of course for those of us who have been a little irresponsible with our credit cards (ahem…), a higher Fico score makes you a more desirable lender – you’ll be able to renegotiate rates with your current lender or simply move your debt to a more ‘understanding’ competitor!
How is a Fico score calculated?
For obvious reasons, the exact formula Fair Isaac Corporation (FICO) uses to calculate your score is a closely guarded secret. Having said that, we do know the general formula. The variables used to calculate your score, as well as their approximate weighting are:
* 35% is based on your payment history. Being late on payments in the past makes creditors nervous. Note, however, that this only includes payments later than 30 days past due
* 30% is based on your credit utilization. Your utilization is calculated simply by dividing your current balance by your credit limit. For example, if your current balance was $500 and you had a credit limit of $2000, your utilization would be 500/2000 = 0.25 = 25% utilization.
* 15% is based on the length of your credit history. Lenders believe you are higher risk if you’re inexperienced.
* 10% is based on the types of credit used (e.g. installment loans, mortgages, credit cards and so on). Generally speaking, a mixture of different types of credit will increase your score.
* And the remaining 10% is based on how much attention your credit report has received lately. How many new credit accounts you’ve opened recently, how long it’s been since you opened a new credit account, how many requests you’ve made for credit recently, and crucially, how long its been since lenders have requested credit information on you.
How do I raise my Fico score?
There are numerous ways for you to increase your credit rating. We recommend you check out our article ‘15 ways to increase your credit rating’ for a full breakdown. Here are several of the most common methods:
Dilute bad credit with good – The fastest way to increase your Fico score is successfully applying for new credit and then demonstrating that you can use it responsibly by paying all your bills on time.
Keep your credit utilization low – Maxing out your cards makes potential lenders very nervous. Try to keep your credit utilization below 25% on each card to avoid coming across as a lending risk.
Dispute any inaccurate information on your file – Credit reporting agencies do make mistakes, so obtaining your credit report and carefully reviewing it is an absolute must.
Obtaining your Fico score
Contrary to popular belief, there isn’t a single Fico score that all lenders check out to determine your credit-worthiness. In actual fact, there are separate Fico scores for different types of loans – one for mortgages, one for automobile loans and one for consumer credit. Your Fico score will also differ depending on which credit reporting agency (Equfax, Transunion or Experian) performs the calculations. Usually the spread will be fairly inconsequential, but occasionally it can be as high as 50 points because each CRA uses slightly different calculation formulas.
By law you’re entitled to one free credit report from Equifax, Transunion, and Experian (get them online here). If you’ve already used up your free annual report or you’d like to monitor your score on a more regular basis, the Fair Isaac Corporation’s website, myFico, offers several worthwhile packages.
Whatever your current situation, improving your Fico score is a lofty and worthwhile goal that will save you big bucks over the long run.