Explainer

What is a FICO Score and Why is it Important?

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What is a FICO Score and why is it important that you both know what it is and track it? Let’s review the details.

If you’ve ever applied for a loan of any sort, you’ve probably had your banker ask you what your FICO Score is. For many, that’s the extent of their knowledge or experience with it. Given that a good or great FICO Score can greatly impact your financial future, let’s get educated on what exactly a FICO Score is and why it’s important to pay attention to it.

What is a FICO Score?

A FICO Score (aka credit score) is a three-digit number derived from your credit reports. Higher is better, a FICO Score is used by lenders to determine the risk of loaning you cash for things like credit cards, home mortgages, and car loans. Your FICO Score will impact how much a lender will loan you, the length of the loan as well as the interest rate.

FICO Scores can be used for more than just borrowing money. They are also used by utilities (gas and electric) and mobile phone companies when opening a new account. Insurance companies may also use a special version of your FICO Score to determine what kind of a risk you may present and then base their rates on it.

Where did the Term FICO Originate?

You may be wondering how the term FICO Score came about. FICO is short for Fair Isaac Corporation. The founders of the company were William R. Fair and Earl Isaac. A little over 30 years ago, the company introduced the FICO Score to grade creditworthiness for both lenders and borrowers to utilize.

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FICO Score Ranges

As mentioned earlier, the higher your FICO Score, the better. The FICO Score ranges are:

<580PoorWell below the average U.S. borrower and a high risk
580-669FairBelow average, but you may be able to get a loan
670-739GoodAt or a bit above the U.S. average, most lenders will issue loans
740-799Very GoodAbove average, considered a good borrower
800-850ExceptionalWell above average and a great borrower

Ideally, your FICO Score should be at or above 670. A score under 670 can make it very hard to get a loan or credit card. If you can get credit at all, the rates and terms will not be favorable, as you are considered a higher risk of defaulting on the debt. The higher your score, the more favorable the terms of your borrowing will be. For example, have you ever noticed ads for cars that tout a low-interest rate and state “for well-qualified buyers?” You’ll need an excellent FICO Score to qualify for those rates as lenders are not interested to give low rates to borrowers who are likely to default on the loan.

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How are FICO Scores Calculated?

You may be wondering what goes into the FICO Score formula. A FICO Score is calculated based on your credit report’s many data pieces, grouped into five different categories. The percentage of importance is what follows in our list, though it can vary based on the individual, and these are just estimates. Also, keep in mind that credit reports can change frequently, and it’s hard to determine which item that may have changed impacted the FICO Score.

Payment History35 percent
Accounts Owed30 percent
Length of Credit History15 percent
New Credit10 percent
Credit Mix10 percent

Payment history is the most critical category and looks at whether you’ve paid your debts on time.

Amounts owed looks at how much of your available credit you are using at one time.

Length of credit history looks at how long your credit accounts have been in existence and how they have been used. The age of the oldest and newest accounts is significant in the calculation as well.

New credit looks at the recent activity of opening new accounts. Opening several new accounts in a short time will generally harm your score.

Credit mix looks at the mix of the different types of credit accounts you have. These accounts can be credit cards, retail store cards, gas cards, HELOCs, mortgages, auto loans, and student loans. If you have a good mix of different types of accounts and always pay them on time, that will positively impact your score.

Conclusion

These are the basics on FICO Scores; there are other complexities and nuances that mere mortals do not have access to, but what we’ve provided here should help you understand your score. Your FICO Score is a three-digit number that can significantly impact your life, and understanding it is the first step towards raising it and improving your financial future.

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