One concept in the credit industry that is hard for consumers to understand is their “credit score”, or FICO score. FICO is an acronym for the company that developed the most widely used mathematical formula for computing credit scores, Fair, Isaac and Company. The term is thrown about, and because it is hard to understand, it can take on a complex quality to many.
When a credit report is requested by a lender, it contains the financial history of credit transactions, physical addresses, employment history and data on any liens or collection actions upon that person or business entity. These files are maintained by consumer reporting companies, including the “big three”, Experian, Equifax, and TransUnion. Information is added whenever a person or business applies for credit or loans. It is kept on record for up to ten years, in the case of bankruptcy. Most records drop off after seven years.
The report shows any accounts that are open, closed, in collections, and any liens that exist. From this information, and using a complex mathematical formula, a FICO score is created. It can range from 500 to 800 points, with high scores resulting in offers of lower interest. High scores are achieved by maintaining a prompt payment history, having a low debt to credit availability ratio, and other factors such as activity level on the file. If you make many applications for loans, it will be reflected on the report and scored lower because it looks like you are desperate to obtain credit. If all your accounts are maxed out, your credit score will be lowered.
The credit score is an indicator of risk. The best score is between 750 and 800 points. The lowest is 500 to 549. To get a better rate, you want to be at least at 620 or above, and preferably above 760. The score is a number the lender can assess risk factors at, as to whether or not you may be able to make payments. Obviously, you want to do all you can to keep this score higher.
One area creditors look at is longevity. This includes address and employment stability, but also how long you have used and maintained good credit. Some people think paying off and closing credit accounts is good, but they should keep them open, and not use them. This would reduce the debt to credit limit percentage in the formula and help drop the score. Having a credit account for a long period of time is also beneficial and another reason to not close the account.
There are five main areas evaluated in the FICO score:
1. Payment history, (35%), paying on time, keeping up to date as possible
2. Outstanding balances, (30%), the debt to credit ratio
3. Length of credit history (15%), longevity factors
4. New Credit (10%), applications and rejections, desperation factor
5. Types of Credit (10%), mix of retail, bank cards, installment, finance company and mortgage loans, and total number of accounts.
Some credit can be rejected because of the score and the reason indicated can be either too much credit or not enough credit, too many mortgages, or not enough history. This is why understanding a credit score can be confusing to consumers.
In many cases it is beneficial to work with a credit counselor, a debt reduction agency, or credit repair company to work to improve a credit file. By making some strategic moves, consumers can boost their FICO score in a short time. By making mistakes, they can ruin their chances for obtaining credit. Professional credit repair assistance can save thousands of dollars in the long run.