Lenders in the United States nearly always check your credit when you ask for a loan or line of credit. Furthermore, your FICO score is the first item that will be looked at before any other information in your credit report.
Although there are several types of credit ratings, FICO scores have gained widespread acceptance and usage. The specifics of how FICO ratings are calculated and what influences them are important to know if you want to improve your credit.
What Exactly Is a FICO Score?
Your FICO score is what most people mean when they talk about your credit. In 1989, Equifax, Experian, and TransUnion, the three largest credit bureaus, contracted the Fair Isaac Corporation (FICO) to create an algorithm to universally and reliably compute ratings.
Even if all three credit bureaus have the same information on you, they will produce slightly different scores since they each requested slightly different algorithm models. Quite the opposite is true: since some creditors report to only one agency while others to all three, the information used to generate credit scores varies widely between the three.
There have been several revisions to those initial algorithms since then, the most current being FICO 10. However, different financial institutions may opt to utilize different versions of credit rating systems. The FICO Scores 2, 4, and 5 from Experian, TransUnion, and Equifax are commonly used by mortgage lenders.
Although there are some subtle distinctions between them, all of these scoring models use essentially the same information to arrive at credit ratings. Also, the range of possible values for these ratings is the same.
FICO Score Ranges
Although credit ratings under 500 are technically possible, they are extremely uncommon.
A good credit score is roughly represented by the following:
- A credit score below 600 is considered to be very bad. It will be challenging to secure a rental property or a loan of any type.
- Bad credit score of 600-649. There may be more leasing and financing alternatives, but you can still count on paying a hefty interest rate and cost. You are still ineligible for several financing programs.
- Grades between 650 and 699 are considered passing. Even if you have access to most forms of credit, you will likely be charged greater interest rates and fee percentages than those with higher credit scores.
- Good credit scores between 700 and 749. You may count on modest interest rates, fees, and less restrictions.
- Excellent credit score of 750–799. In an effort to secure your business, lending companies will actively pursue you while offering attractive rates and conditions.
- Credit scores above 800 are considered excellent. You have access to any and all forms of credit and may bargain for the lowest possible fees and interest rates.
If your credit score is lower than 700, you should make an effort to raise it.
How Is Your FICO Score Calculated?
The credit bureaus’ scoring algorithms take into account a wide variety of information. However, here is how FICO scores are often calculated as a matter of thumb:
- The most important aspect of your credit score is your payment history, which includes how reliably (or inconsistently) you have paid your debts. The length and regularity of your payment history accounts for 35 percent of your credit score.
- Credit utilization is the proportion of your total credit limit that you actually use. If you have a $1,000 credit limit and are currently carrying a $200 load, your credit usage ratio is 20%. It accounts for 30% of your total grade.
- In terms of length of credit history, the longer your accounts have been open, the better. The average age of your accounts is factored into 15% of your credit score by the credit agencies.
- The credit reporting companies favor customers who have a diverse range of credit accounts. One common combination is a home loan with two or three revolving lines of credit (credit cards, for example) and an installment loan (for a car, for example).
- Ten percent of your score is based on how varied your credit lines are.
When applying for new credit, your credit score may take a hit for up to six months if the lender conducts a “hard investigation.” Ten percent of your score comes from how often (or how rarely) you apply for new credit.
That is to say, there are a few basic guidelines you may follow to improve your credit score:
- Always be prompt in making monthly bill payments.
- Always make the minimum payment or more on your credit cards.
- Don’t close down your older credit cards, even if you aren’t using them.
- Shop around for interest rates by providing your credit report to potential lenders before allowing them to draw your credit.
Why Is Your FICO Score Important?
For lenders, the biggest concern is losing their money if they loan it to a borrower and they never see it again. They increase interest rates in proportion to the perceived riskiness of a loan.
And beyond a certain point of risk, they withdraw all financing. To assess a borrower’s dependability and credit risk, the three credit bureaus and Fair Isaac Corporation developed algorithms. A person with a credit score of 820 has demonstrated time and time again that they can be relied upon. No matter the nature of the loan, they always make timely and complete payments.
Your credit score is important if you want to get mortgages, cars, low-interest credit cards, and student loans. When you apply for a loan, the lender will check your credit score to see how much of a risk you will be as a borrower. If you have terrible credit, your financing alternatives will be limited and costly. So keep an eye on your credit score if you want low-interest loans, or loans at all.
How to Determine Your FICO Score
Get your free credit report from each of the three main bureaus once each year at AnnualCreditReport.com. Three reports spread out over the course of the year, one every four months, is a wonderful method to check for inaccuracies that lower your score without having to subscribe to a costly credit monitoring service like myFICO.
However, your credit score is not included in the complimentary copies of your credit report. Fortunately, there are a number of different methods available at no cost to you for keeping tabs on your credit history and score.
For instance, I monitor my financial status and credit rating using Mint. Keep an eye on your credit score for free with Credit Karma’s credit monitoring service. To keep the lights on, both of these free options will show advertisements and links to affiliate items.
Is a FICO score equivalent to a credit score?
For all intents and purposes, a FICO score is only one form of credit score. However, the vast majority of lenders utilize FICO scores as their preferred credit score, making the phrases “FICO score” and “credit score” interchangeable for all intents and purposes.
What Is an Appropriate FICO Score?
Although opinions vary, in general, a credit score of 700 or more is considered to be in the “good” range. Although some may set the limit at 720, others may choose a lower number, such as 680. Take the answer with a grain of salt because it is based on someone’s own opinion of what constitutes “good” in this situation.
Unless you pay cash for all of your major purchases, including a home and a car, your credit score has far-reaching consequences.
Take into account a down payment of $10,000 and a mortgage payment of $1,300 per month. If your credit score is 800 or above, a mortgage with a 3% down payment and an interest rate of 3% could be within your reach. Therefore, a home costing $310,000 would be within your price range.
Or, put another way, pretend your credit score is 550. So, you’ve been approved for an FHA loan with a 5% interest rate and a 10% down payment. You will be unable to buy a property worth more than $100,000 due to the size of the down payment alone. The maximum home price you might afford with a credit score of 580 and a 3.5% down payment is $230,000.
How good your credit score is is important. Keep an eye on it, correct any mistakes, and work to improve your credit, and you may be surprised at the new opportunities that present themselves.