What is a FICO Score?

FICO® scores are a dynamic sequence of three-digit numbers ranging from 300-850 used as an independent standard measure of a person’s credit risk. 

Lenders review FICO scores to determine how likely a person is to repay debt. A low FICO Score could mean being turned down for a loan or facing a high interest rate. In contrast, a high score may translate to paying less interest since you’ve proven responsible with credit. 

Because scores are based on analytics rather than human biases, it’s easier for lenders to make fair and consistent lending decisions. 

With a lot riding on these three digits, how is it calculated, and what is a FICO score?

What is a FICO Score?

The Fair Isaac Corporation introduced the FICO score in 1989 as a measure of consumer credit risk. It’s a three-digit number, typically in the 300-850 range, representing the risk a prospective borrower poses to a lender based on credit history. It’s based on data taken from credit reports from the three major credit bureaus: Express, Equifax, and TransUnion. It pulls data, including payment history, length of credit history, and other indicators to calculate the score.

FICO models rank your credit score on its scale. If your score is on the high end of the range, it signals you’re less likely to fall behind on credit obligations. But if you’re on the lower end of the score, the lender knows they are at a greater risk for late payments. 

To appreciate your FICO score and how it’s calculated, it’s helpful first to understand why companies care about your score. Everyone from credit card issuers to insurance companies to mortgage lenders use FICO scores to determine eligibility. Lenders widely use FICO scores to assess risk. Lenders are trying to determine if they loan you money and how likely you will pay it back in full and within the agreed-upon timeframe. 

FICO isn’t the only metric weighed during a loan decision. Lenders will also check your income and other factors. Certain lenders have a threshold your scores must meet to get approved.

Your FICO doesn’t solely benefit the lender. The score also helps you by providing fair and fast access to credit. A higher score makes it easier for you to qualify for a loan and may result in you receiving a better interest rate. Knowing your score and ways to improve it will better prepare you for a loan application. 

Components of a FICO Score

FICO uses a proprietary formula to calculate your credit score. Although the specific calculations are unknown, FICO has shared the factors they consider. 

Five major factors contributing to your FICO score are:

1. Payment History (35% of your score). Payment history is the most influential factor in your FICO score. It includes on-time and late payments on credit accounts and public records related to nonpayment, such as bankruptcy. Paying your bills on time is critical for earning an excellent score. Late payments and accounts in collections or bankruptcy can hurt your score. 
2. Amounts Owed (30% of your score). How much you owe and the different types of credit accounts you have are all factors in your score. Lenders want to understand the amount of credit you’re using compared to the amount you can access. This percentage is your credit utilization rate. For example, if your credit card limit is $5,000 and you have a balance of $2,500, your utilization rate is 50%. You want to aim for 30% or less. 
3. Length of Credit History (15% of your score). Your score considers opened and closed accounts. Lenders want a history of accounts in good standing. A long account history shows you’re able to manage credit properly. Lenders will view someone who has never had a late payment in 10 years as a lower risk than someone whose oldest account is only two years old.
4. New Credit (10% of your score). When you apply for any credit, lenders will check your credit report, which initiates a hard inquiry. Hard inquiries appear on your credit report for 24 months and cause a minor dip in your score. Before opening a new account, consider whether having extra credit is worth the slight drop in your score.
5. Credit Mix (10% of your score). Credit is typically categorized as installment and revolving. A mortgage and auto loan are examples of installment credit, while credit cards are revolving. Different types of credit are managed — well, differently. Lenders like a mix of credit because it shows you can manage various types.

Understanding Good vs. Bad FICO Scores

Every lender or creditor defines scores and criteria to determine a good FICO score, which they use, along with other information, in the loan approval process. 

Your credit report information continually changes, so your FICO score updates frequently. But the fact remains, the higher your score, the lower the risk to lenders.  

Here’s how FICO breaks down credit scores:

• Below 580: Poor
• 580 to 669: Fair
• 670 to 739: Good
• 740 to 799: Very Good
• 800 and above: Exceptional

Read more about this top range in our post on what makes a perfect credit score.

Improving Your FICO Score

The good (and sometimes bad) news is that because FICO calculates your score based on your credit information, you significantly influence improving it. 

To improve your FICO score:

• Check Your Credit Report. Monitoring your credit report allows you to take preventative measures and other actions to ensure correct information. If you find an error, contact the bureau directly to correct the error and verify your information is accurate. 
• Pay Your Accounts on Time. Making regular, on-time payments assures prospective lenders you’re responsible with your money. Even if you can’t pay your cards off monthly, making the minimum payment regularly will keep your accounts in good standing.
• Lower Your Credit Utilization. Credit scoring looks at how close you are to being “maxed out.” Lowering your utilization will increase your score.
• Optimize Your Account Age. As the average age of your accounts increases, you’ll receive a bump to your credit score. This doesn’t mean you need to close your newest cards, but be conscious of how many new accounts you have. 
• Limit Credit Inquiries. Although minor, the number of times lenders check your credit can impact your credit. Limit the number of hard inquiries.

Common Misconceptions About FICO Scores

Misinformation and confusion regarding FICO scores is rampant. Getting the facts can lead to positive financial decisions. If you’re trying to work on your credit score, it’s vital to understand how scoring works. Let’s debunk some common misconceptions.

Myth 1: Checking your score will lower it. 

False. Monitoring your score can help you track progress when building credit. Applying for a credit card, student loan, personal loan, mortgage, or car loan requires a hard pull, which temporarily dings your credit score. 

The three major credit bureaus are required by law to provide you with a copy of your credit report at your request, free of charge, at least once every 12 months. When you check your credit score, it triggers a soft inquiry. Soft inquiry, also called soft pulls, will not affect your score. Soft inquiries are often used to prequalify for a credit card offer or insurance quotes and sometimes during an employment background check.

Myth 2: Carrying a credit card balance boosts your credit score. 

Nope. Carrying a balance on your credit card has no benefit. It can actually hurt your score and cost you money since a credit score rewards an open and active account in good standing with a zero balance. 

Lingering balances affect your credit card utilization rate. The higher the balance, the more your utilization rate will increase, which hurts your credit score. Not to mention, paying interest on your balance is not a good use of money if you can afford to pay it off.

Myth 3: You need to be rich to have a good credit score. 

Not even close. Although a lender will use income to grant credit, your earnings are not a factor in determining your credit score. So, having a high salary doesn’t guarantee an excellent score range, and a lower wage doesn’t mean you will have a poor score. 

Myth 4: You only need to worry about your score when you’re older. 

Please don’t wait. The minimum age you can apply for credit is 18. That’s the age to start worrying about your score. Since the length of credit history is a substantial factor in your score, the sooner you establish credit, the better.

Myth 5: Student loans don’t affect my credit score. 

If only. You need to pay all your bills on time, which includes your utilities, student loans, and any bills you might have. Autopay options can keep you organized and an easy fix to avoid missing a due date. Certain companies will offer you a discount if you set up autopay.

Myth 6: Married couples share a FICO score. 

Yeah, no. Married couples don’t share credit scores or credit history. Every person has a distinct credit score. But if you add your spouse as an authorized user, the account will most likely appear on their credit report. If they’re making on-time payments, it could help build your credit score. Conversely, if you’re late, it could ding their credit.

Focus Federal Can Cut the Confusion

Focus Federal Credit Union can help you understand your FICO score. Our financial education team also will walk you through ways to improve your score and gain access to greater financial options. Contact us today to learn more.