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- Developed by the Fair Isaac Corporation, FICO is the oldest and most widely used credit scoring model.
- Your payment history and accounts due are the most important factors in calculating your credit score.
- FICO 10T, the latest generation of the credit score model, takes into account your monthly credit balances over the last 24 months.
If a lender is looking at your credit score, chances are they’re looking at your FICO score. This helps financial institutions and lenders determine your creditworthiness and set interest rates or loan terms that match your score. Credit scores range from 300 (extremely poor and very limited credit opportunities) to 850 (excellent credit opportunities) and fluctuate based on various factors, such as late payments, debt to credit ratio, accounts receivable , the age of your credit accounts, and more.
The three credit bureaus – Experian, TransUnion and Equifax – each establish a consumer credit score based on your purchase and payment history, and these scores use the FICO scoring system.
What is a FICO score?
FICO is a credit scoring model, which mirrors information on your credit report and condenses it into a single three-digit number. It is named after Fair Isaac Corporation, the company that created the numerical credit scoring system in 1989. Although the data analytics company renamed the company to FICO in 2009.
As a three-decade-old credit scoring model, FICO is the most widely used scoring model in the market. FICO estimates that about 90% of lenders use its scores to decide how much credit to extend to consumers and how much to charge them.
Your FICO score may be different in each office as each agency may have slightly different information about your credit history (although it should be quite similar – if you notice a big difference, call the office to find out what’s going on) and you may have more than one FICO score at an agency depending on the type of loan you applied for.
Although you have separate FICO scores from each office, you also have different FICO scores based on FICO generation. There are 10 iterations of FICO, named FICO 1-10. The most commonly used versions for general loans are still FICO 8 and 9 despite the release of FICO 10 in 2020.
Credit card companies and auto lenders also use FICO 8 and 9, but have versions tailored to their respective industries: FICO Bankcard and FICO Auto. Mortgage lenders typically use previous generations of FICOs, known as classic FICOs. These include FICO 2, 3 and 5 depending on the credit bureau.
Trending credit data and FICO 10T
When FICO released FICO 10 in 2020, it also released FICO 10T. This credit score model looks at your monthly credit balances for the past 24 months as an indicator of future performance, also known as trend data. To maintain your FICO 10T score, you will need to carefully monitor your credit card balances from month to month.
You won’t have to worry about that for a little while because FICO 10T has not yet been widely adopted. Additionally, FICO also released a FICO 10, which does not use trend data. However, the Federal Housing Finance Agency just announced in October 2022 that Freddie Mac and Fannie Mae will require the use of FICO 10T, which will take several years to implement.
What is a good FICO score?
FICO divides its 300-850 range into five risk categories. In ascending order, they are poor, fair, good, very good and excellent. A good FICO score is between 670 and 739, depending on the official range. Each risk category and their corresponding score ranges can be found below:
Although FICO has an official “good” category, that doesn’t necessarily mean you’ll be eligible for great rates. For example, super-preferred customers in the auto loan industry must have at least 780 to get the best interest rates.
Since April 2021, the average FICO score of a US credit holder has reached an all-time high of 716, where it remained in April 2022. Consumers are increasingly aware of the dynamics of holding and building up credit, make fewer bad debts and make smarter decisions about their financial health.
The best way to make these decisions is to understand what goes into your credit score in the first place. Let’s take a look at these components and what they could mean for your credit. Here’s some information on the types of factors that contribute to your credit score, what might explain a sudden drop, and how you can intentionally work to improve your credit over time.
How is a FICO score calculated?
The exact algorithm used to calculate FICO is a closely guarded secret, but we have a general overview of how your credit report is condensed into your FICO score.
Payment history
FICO heavily factors your payment history into your overall score. This is perhaps the most obvious – if you are consistently behind on your payments, your credit will suffer. This part of your score is based on your late and on-time payments, as well as bankruptcies in your credit history.
Amounts due
Your Account Due Balances is another important part of your FICO score. Although using credit wisely (for example, paying off your credit card balance in full each month and not charging more than you can afford) can help improve your credit score, a debt to high credit can hurt your FICO score.
The term debt-to-equity ratio refers to the amount of money you owe compared to the amount of credit your lenders have extended to you (your credit limit); your debt ratio should never exceed 30% to keep your credit score in good shape, although it is better to be around 1-10%.
Other factors taken into account here are the percentage of your mortgage or car loan that you have paid off and the number of your accounts that have balances.
Length of credit history
If you’re a new borrower, don’t expect to start out with a perfect 850 credit score. Rather, it’s your responsibility to prove your creditworthiness, and you’re essentially starting from scratch. As you establish your accounts and make your payments on time, your credit score will improve.
Whether you’re new to the credit game (a young person, say, or a new immigrant) or have a long credit history, it can be a good idea to maintain healthy old credit accounts even if you don’t plan to. to stop using them to avoid sudden changes in your credit score. Closing accounts that have established and maintained your FICO score may end up lowering your score.
Closed credit cards in good standing will remain on your credit report for 10 years. That said, the account is paid for in full, leaving it alone without closing it can keep your credit score healthy (as long as you’re not paying an annual fee just to keep your account open).
Types of credit
There are two main types of credit: revolving credit and installment credit. Installment credit is essentially a loan that is no longer available once repaid. For example, if you take out a loan from the bank, that loan does not replenish once you have fully repaid it; it is an installment loan.
The second type, revolving credit, is credit that becomes available once repaid. Credit cards are revolving credit because you can pay them off and then reuse them immediately.
Diversifying your credit is a sound strategy as long as you can keep up with payments and interest rates, and this can be done through mortgages, retail accounts, credit cards, and more.
New credit
The number of times a serious inquiry is ordered into your account affects your credit score, as well as the number of new lines of credit you open.
Opening a new account before mastering old accounts can hurt your credit score because it increases the amount you’ve borrowed, even if it hasn’t yet been spent. On the other hand, opening lines of credit is necessary to establish credit in the first place. It is therefore good practice to open a new line of credit only if this line offers advantages that outweigh the negative effects, that you are on time with payments and that you will be able to meet the schedule with the new line.
How to Improve FICO Score
First, avoid late payments at all costs. Almost everyone misses a payment at some point; the average resident of a major US metropolitan area has an average of six missed payments in their credit history. Most banks and lenders now offer automatic, paperless payment options that allow consumers to set up payment plans in just minutes. Take advantage of these options if you tend to be a bit forgetful, as missed payments can significantly hurt your credit score and even prevent you from being approved for lines of credit in the future.
Pay attention to interest rates and possible annual fees, and avoid paying too much interest on your loans by maintaining a balance of 30% or less.
It’s good to eventually diversify your credit to build creditworthiness at all levels, but start with just one or two lines to establish yourself. It’s easy to get caught up in the credit card game because of the opportunity to earn great rewards, but you don’t want to lose control.
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