Understanding FICO

FICO is a registered trademark of Fair Isaac Corporation, which is an American corporation founded by engineer Bill Fair and mathematician Earl Isaac. The FICO score is a scoring system used to measure credit risk. The three major consumer reporting agencies; Equifax, Experian and TransUnion use the FICO score. It is simply a system for measuring credit much like farenheit is a system for measuring temperature.

FICO scores range from 300 to 850 with most Americans falling somewhere in the 720 to 730 range. FICO does not reveal the exact method used in calculating scores, but the following is a general idea of where the score comes from:

  • Aproximately 35% of the score comes from your payment history. This is more than any other single factor which is why you need to always pay on time. All creditors will report late payments at 60 days but some may report when a payment is 30 days late.
  • Debt-to-credit-limit ratio accounts for about 30% of your credit score. To keep a good credit score, most experts agree that you should never use more than half of your limit, while keeping it below 30% is even better. For example, if you have a total credit limit of 10,000 on all your credit cards, you should not let your balance go above 5,000, and keeping it below 3,000 would raise your score even further.
  • Credit history accounts for about 15% of your FICO score. The longer you have credit accounts, the higher your score. The only thing that will affect this factor is time.
  • Another 10% of your score is determined by the types of credit accounts on your report. Managing a variety of credit accounts such as revolving credit (credit cards), auto loan and mortgage will boost your score.
  • The last 10% is calculated from the number of recent credit checks. A lot of credit checks whithin a short period of time will lower your score.

Some of the factors that affect your score may seem like they don’t make a lot of sense, but it’s all based on statistics. It’s very similar to car insurance; lower risk equals lower rates. For example, young men pay more for car insurance because they are more likely to file claims than older women. Likewise, someone who, say, keeps a high balance or applies for a lot of credit is more likely to default on their accounts than someone who keeps a lower balance and has not applied for credit recently.

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