Whether you are just starting out with your finances or you have been on your own for a while, understanding your FICO score is a must. A FICO (Fair Isaac Corporation) score is used by approximately 90% of all lenders. It is a credit rating that shows the person’s credit and payment history and ability to obtain and repay credit. Your FICO score will affect the interest rate of a loan, how much a lender is willing to lend, etc. FICO scores range from 350 to 850.
How do you know which FICO scores are considered good? Whenever a lender receives a loan application, they need to know the risk they would be taking if they issue the loan. The majority of lenders will run a credit report and will take the FICO score into consideration. The higher score the better it is for the lender and the borrowing. A higher score means you are credit worthy and at a lower risk for defaulting or not repaying the loan.
How are FICO scores calculated? FICO scores are calculated using specific credit and payment history that has been reported by credit reporting agencies. There are basically 5 areas considered for your credit score as found on www.myfico.com:
- Payment History
- Amounts Owed
- Length of Credit History
- Credit Mix
- New Credit
Payment history is one of the first things a lender wants to know. Past payment history is a good indication of the future payment history for an individual. Unforeseen circumstances may arise that affect a consumer’s ability to repay but generally the payment history is reflective of a consumer’s payment habits.
Amounts Owed will be a factor considered as the lender will want to know the financial burden the borrower already faces. Just because a lender owes a large amount of money does not mean the borrower will be a potential credit risk but this must be taken into consideration by the lender.
Length of Credit History will give a lender a better picture of your payment history. A short credit history does not reveal as much about the lender as a longer credit history.
Credit Mix is made up of the different types of credit you have. For example, a consumer might have 3 major credit cards, 2 mortgages, one department store credit card, an automobile loan, a boat loan, and 2 student loans. While an automobile loan will decrease with the passage of time, a credit card balance could continue to increase.
New credit reveals how much the consumer continues to borrow. Keep this in mind each time you are offered a credit card for a particular store. Remember that if you open a credit card at a particular store you are more likely to spend more at that store. This is one of the reasons the cashier asks you if you want to save “15%” on your purchase by opening a credit account with them.
Items that can negatively affect your FICO score are late payments, short credit history, reaching your credit limit, not paying the minimum payment, opening new credit accounts, etc. Items that can positively impact your FICO score include making payments on time, long credit history, paying off balances, paying more than the minimum payment, and refraining from opening new credit accounts.
Be an educated consumer. Know your FICO score and make improving it a priority.