A FICO score is a numerical representation of an individual’s credit worthiness. It is a credit scoring system developed by First Isaac and Company for use by lending companies in determining the risks entailed with every credit application. It was introduced in 1986 amid the clamor from consumers to have a standardized method of evaluating loan applications. It has been the standard for scoring the credit risks of loan applicants since then.
Before that, lenders rely mainly on information contained in credit reports supplied by the 3 Credit Reporting Bureaus – Equifax, Experian, and Trans Union. Based on information contained on these credit reports, lenders evaluate the credit risks on their own. More often than not, lending decisions were subjective. FICO’s coming changed all of that and made the lending decision making quick, objective, and accurate.
How FICO Score is calculated
FICO uses a unique proprietary algorithm to process and digest both negative and positive information contained in a credit report and spew it out in a numerical form that may fall between 300 and 850. The range represents the various spectra of risks entailed with any credit undertaking.
Little is known about how exactly the FICO algorithm works as it remains a closely guarded secret of its developer. The only thing the company ventured out is what risks each range represents and how much weight it gives to various credit report data it uses.
What the FICO numbers represent
FICO does not have a set standard in determining the cut-off score for each level of risks. This has been left for the lenders to set themselves based on their own criteria and outlook. However, based from actual experience, a score above 700 is considered a good score with scores in the upper 700s likely to get you a good interest rate on your loan
Scores between 620 and 690 are viewed by most lenders as moderately good but your credit history may have to pass through the eye of the needle before you can get a loan approved. You are also likely to be charged with a higher interest rate.
Scores lower than 630 are considered subprime and indicate that the undertaking may be too risky for the lender to tackle. Loan applications from individuals with these scores are usually turned down or denied.
The Five Key Data that determines your FICO Score
There are five key data on your credit report which FICO uses to calculate your credit score. They are:
- Credit Payment History – This accounts for 35% of your credit score. Please note however that for FICO to start calculating your score you must have at least 3 accounts which must have been open for at least six month.
- Amounts Owed – This will show how you utilized your available credit and it accounts for 30% of the score.
- Length of Credit History –Longer credit histories have better chances of getting better scores as these make up for 15% of the score.
- Types of Credits used – The credit mix you availed of constitutes 10% of your score.
- New Credit – How many new accounts you opened over a short span of time accounts for 10% of your score.
FICO Score has been in the market for the longest time and have been used extensively by banks and other lending institutions. Without a doubt, it is effective in predicting risks for lenders otherwise people would have started looking for something better long ago. The only problem is, it has squeezed out by design the ‘thin file’ consumers or people with hardly any credit history to show since credit payment history is already 35% while length of credit history is 15%. The ‘thin file’ consumers represent roughly 18 to 25 per cent of the country’s adult population numbering from 25 to 50 million consumers.