One of the first problems faced when attempting to improve finances is understanding how credit works. If we do not understand how something works, we typically misuse it; this is typically the case when it comes to credit. By misusing credit, we get into debt. When we get into debt, we become discouraged. And when we become discouraged, we may fall behind on our payments. Knowing what a FICO score is, how a FICO score is calculated, and knowing what your FICO score is will help you in your journey to financial prosperity.
So what is a FICO Score?
Well, a FICO score is simply a rating used by creditors to determine the financial risk involved with extending credit to a borrower. However, a FICO Score is not just any credit rating, it is specific. The FICO Score was developed by Fair Isaac Corporation to create a standard method for evaluating credit. It takes into account your credit report(s), and creates a score based upon your credit history. Older items have less impact than newer items. The three major credit reporting bureaus (Experian, TransUnion, and Equifax) use FICO scores. It is important to remember that you will have three different FICO scores, as each is calculated from the credit report from the three respective credit bureaus.
How is a FICO score Calculated
First and foremost, your FICO score is calculated from your credit reports. The information in your credit report is then given a weight, and is evaluated to determine your FICO score.
What Information is in a Credit Report
- Personal Information (For identifying, not used to determine scores)
- Full Name
- Date of Birth
- Social Security Number
- Current Address
- Accounts Summary (For each open line of credit)
- Account Type (Mortgage, Loan, Credit Card, etc.)
- Company (The creditor)
- Account Number
- Balance (May not be accurate if account activity is high)
- Negative Items (A flag for whether there are problems)
- Inquiries (Credit inquiries from the last two years)
- Date of inquiry
- Requestor (Company that made the inquiry)
- Negative Items
- Account Type
- Status (e.g. Pays as agreed)
- Delinquincy (e.g. 30 days past due)
- Negative Description
How does my FICO Score Effect Me?
If you have a higher FICO score (720+) you can get better rates on loans, mortgages, and credit cards. If you have a lower FICO score (620-) you will get worse rates on loans, mortgages, and credit cards. This can make a significant financial impact on you. For instance, every one percent of interest is about $100 per month per $100,000 borrowed on a 30 year fixed-rate mortgage. Someone with poor credit may be paying hundreds of dollars more per month than someone with the same debts but with better credit. That is hundreds of dollars per month that can be saved and/or invested for a house, vacation, retirement, and/or gifts.
How do I Check my FICO Score?
The best place to check is right from the horses mouth, the Fair Isaac Corporation. They have a website that is absolutely wonderful for check your FICO score called MyFICO. This is not free, mind you (Last I checked it was about $20), but it is a good investment in your financial future. They also have simulators that can give you an estimate to how performing certain actions (making your payments on time for 3 months, paying down your credit card debt, getting a new auto loan) will impact your FICO score.
How Can I Improve my FICO Score?
Well, there are many things that you can do to improve your FICO score:
- Make your payments on time
- Pay off delinquent debts
- Pay down revolving credit (credit cards, store cards, etc)
- Have few credit inquiries
- Have a good debt-to-credit ratio (Don't max out your credit cards)
- Seek the help of a lawyer to remove negative items from your credit report
- Download the essential Credit Repair Guide "Give Yourself Credit" and start on the road to recovery.
- Cut Your Bills in HALF!
- Or do it yourself.
I really hope this has been helpful. Your understanding of credit can really make or break your journey to financial prosperity.