FICO Scores: Why They're Important, How They're Calculated, and What You Can Do to Improve Them

Whether you're applying for a credit card, a personal loan, or a mortgage, the lender you choose looks at many things when deciding what type of offer to make to you, including:

  • Your income
  • How long you have worked at your present job
  • The kind of credit you are requesting
To help them gain a better understanding of your credit risk level, lenders often start by looking at your FICO scores.

You have three FICO scores, one from each of the three credit bureaus:
  • Experian
  • TransUnion
  • Equifax
Each score is based on information the credit bureau keeps on file about you. In the simplest terms, good FICO scores generally result in your receiving the best interest rates on all types of loans. Bad FICO scores, on the other hand, can cost you thousands of dollars over the life of a loan.

How your score is calculated
FICO stands for the Fair Isaac Corporation, which is a leading monitor of consumer credit. Fair Isaac develops FICO scores based solely on information in consumer credit reports maintained at the three major credit reporting agencies.

Your FICO score can range from 350 to 850850 being the best. In determining your score, the corporation evaluates information in five categories:
  • Payment history (35%): This includes information on specific types of accounts, such as credit cards, retail accounts, student loans, installment loans, finance company accounts, and mortgages. It also captures any presence of adverse public records, such as bankruptcy, judgments, suits, liens, wage attachments, collection items, and any delinquent or past-due items.
  • Amounts owed (30%): This category assesses the number of accounts you have and the amount you owe on each. Additionally, the proportion of balances to total credit limits on certain types of revolving accounts is considered.
  • Length of credit history (15%): This information examines the time that has elapsed since a specific type of account has been opened.
  • Types of credit used (10%): This data relies upon recent information about the number of credit cards, retail accounts, installment loans, mortgages, and consumer finance accounts you have.
  • New credit (10%): This category includes the number of accounts you have recently opened.
Keep in mind, your FICO score considers all of the above categories of information. No one piece of information or factor alone will determine your FICO score. For some people, one factor may be more important than it is for others with a different credit history. As the information in your credit report changes, so does the importance of any factor in determining your FICO score. What matters is the mix of information, which varies from person to person.

Good and bad breaks
If your FICO score is 720 or higher, you are likely in good shape. If it's lower than 720, you may need to brace yourself for some frustration. Most mortgage lenders have firm breakpoints. For example, if your FICO score is 699 and the lender's breakpoint is 700, that minute difference could mean an extra half-point on a mortgage loan.

How can you improve your score?
Your FICO score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or reestablishing a good track record of making payments on time will raise your FICO score.

You can also do the following to help increase your score:
  • Pay down your credit card debt to zero and your score can go up by as much as 20 points in 60 days.
  • Get a copy of your credit report and look for errors. This may include:
    • Payments that appear as late but you can prove were paid on time
    • Accounts that aren't yours
    • Old debts that shouldn't be on your report anymore (i.e., negative debts should be taken off your report after seven years; bankruptcies should be removed after ten)
  • Maintaining multiple credit cards may help you in some circumstances. It is better to have four cards at 20-percent to 30-percent capacity than to have one card that's maxed out.
Rapid rescoring
If you're applying for a mortgage, ask whether your lender uses a rapid rescoring service. If so, you can have your credit score rescored in 72 hours; if you've recently improved your score, rescoring may save you money. Rescoring generally costs about $50 per credit account.

Even if you're not in the market for a mortgage or another loan, it is always wise to have a good handle on your FICO scores. It is easier to correct mistakes and improve your score when you don't have an immediate deadline to meet. You can obtain your FICO scores (for a fee), by going to www.myfico.com and clicking on the Products tab. The site also explains in more detail how FICO scores work, includes answers to commonly asked questions, and more.