What is a FICO score and how is it calculated?

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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 owed are the most important factors in calculating your credit score.
  • FICO 10T, the latest generation of the credit scoring model, takes into account monthly credit balances for the past 24 months.

If a lender is looking at your credit score, chances are they are 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, very limited credit opportunity) to 850 (excellent credit opportunity) and fluctuate based on a variety of factors, such as late payments, debit/credit ratio, accounts in collection, age of your credit accounts and more.

The three credit bureaus – Experian, TransUnion and Equifax – each establish a credit score for consumers based on purchase and payment history, and those scores use the FICO scoring system.

What is a FICO Score?

FICO is a credit rating model, which reflects information about your credit report and condenses it into a single three-digit number. It is named after Fair Isaac Corporation, the company that first created the credit rating numerical system in 1989. Although the data analytics firm renamed the company to FICO in 2009.

As a three decades old credit scoring model, FICO is the most widely used scoring model on the market. FICO estimates that approximately 90% of lenders use its scores to decide how much credit to give consumers and how much to charge them.

Your FICO score may be different in each bureau as each agency may have slightly different information about your credit history (although it should be fairly similar – if you notice a large discrepancy, call the bureau to find out what’s going on) and you may have more of a FICO score from an agency depending on the type of loan you have applied for.

While you have separate FICO scores from each office, you also have different FICO scores depending on the generation of FICO. There are 10 iterations of FICO, referred to as FICO 1-10. The most commonly used versions for general lending are still FICO 8 and 9 although FICO 10 will be released 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 generally use older generations of FICO, known as Classic FICO. These include FICO 2, 3 and 5 depending on the credit bureau.

Trend credit data and FICO 10T

When FICO released FICO 10 in 2020, they also released FICO 10T. This credit scoring model looks at monthly credit balances over the past 24 months as an indicator of future performance, also known as trend data. To keep your 10T FICO score high, you’ll need to closely monitor your credit card balances from month to month.

You won’t have to worry about this for a while as FICO 10T has not yet been widely adopted. Additionally, FICO has also released a FICO 10, which uses no trend data. However, the Federal Housing Finance Agency just announced in October of 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 these are poor, fair, good, very good and excellent. A good FICO score is between 670 and 739, according to the official range. Each risk category and its score ranges are shown below:

While FICO has an official “good” category, that doesn’t necessarily mean you’ll be able to qualify for great rates. For example, super prime customers in the auto loan industry must have at least a 780 for the best interest rates.

As of April 2021, the average FICO score for a U.S. credit holder reached an all-time high of 716, where it remained through April 2022. Consumers are becoming more aware of credit holding and building dynamics, they are making fewer delinquency mistakes and they are making smarter decisions for their financial health.

The best way to make these decisions is to figure out what goes into your credit score in the first place. Let’s take a look at these components and what they might mean for your credit. Here’s some insight into what kinds of things 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 layout of how your credit report is condensed into your FICO score.

Payment history

FICO factors heavily into your payment history in your overall score. This is perhaps the most obvious: if you consistently default on your payments, your credit will suffer. This part of your score is based on your late and on-time payments, as well as any blemishes on your credit history.

Amounts due

Your account balances are another significant portion of your FICO score. While using credit wisely (e.g. paying off your credit card balance in full each month and not charging more than you can afford) can help build your credit score, a high debt-to-credit ratio can hurt your FICO score.

The term debt-to-credit ratio refers to the amount of money you owe relative to the amount of credit your lenders have given you (your credit limit); Your debt-to-credit ratio should never exceed 30% to keep your credit score in good shape, although it’s best to stay between 1 and 10%.

Other factors considered here are the percentage of your mortgage or auto loan that you have paid off and how many of your accounts have balances.

Length of credit history

If you’re a new borrower, don’t expect to start with a perfect credit score of 850. Instead, it’s your responsibility to prove your creditworthiness, and you’re basically starting from scratch. As you establish your accounts and make payments on time, your credit score will improve.

Whether you’re new to the credit game (a young person, for example, or a new immigrant) or have a long credit history, it can be a good idea to keep old credit accounts healthy even if you don’t intend to use them anymore to avoid sudden changes in your credit score. Closing accounts that have established and confirmed your FICO score can end up lowering your score.

Credit cards closed in good standing will remain on your credit report for 10 years. That said, the account is paid in full, leaving it alone without closing it can keep your credit score healthy (provided you don’t pay 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 you pay it off. For example, if you take out a loan from the bank, that loan doesn’t pay itself off once you pay it off in full; this is an installment credit.

The second type, revolving credit, is a credit that becomes available once it has been repaid. Credit cards are revolving credit because you can immediately pay them off and use them again.

Diversifying your credit is a healthy strategy as long as you can track payments and interest rates, and this can be done across mortgages, retail accounts, credit cards, and more.

New credit

The amount of times a difficult request is ordered on your account affects your credit score, as well as the number of new lines of credit you open.

Opening a new account before getting a check on your old accounts can negatively affect your credit score because it increases the amount you borrowed, even if it hasn’t been spent yet. On the other hand, opening lines of credit is necessary in the first place to establish credit. So it’s good practice to open a new line of credit only if that line offers benefits that outweigh the negative effects, you’re on schedule with your payments, and you’ll be able to meet schedule with the new line.

How to improve your FICO score

First, avoid late payments at all costs. Virtually everyone loses a payment at some point; The average resident in a major U.S. metropolitan area has an average of six missed payments in their credit history. Most banks and lenders now have automatic and cardless payment options that allow consumers to set up payment plans in minutes. Take advantage of these options if you tend to be a little forgetful, as missed payments can become a major blow to your credit score and even prevent you from being approved for credit lines in the future.

Pay attention to interest rates and any annual fees, and avoid paying too much interest on your loans by carrying a balance of 30% or less.

In the end it’s good to diversify your credit to build credit standing across the board, but start with just a line or two to establish yourself. It’s easy to get sucked into the credit card game because of the potential to earn big rewards, but you don’t want to lose control.

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