The Fair Isaac Corporation Score, known simply as FICO score, is your credit score as calculated by a company when making a decision regarding hiring you. The FICO score depicts the risk a company is facing when hiring you. With the passage of time, credit scores have become a cornerstone of pre-employment screening as well as apartment lease. It is vital to separate fact from fiction when you manage your score.
This credit score is computed using an algorithm developed by FICO. The algorithm gleans your personal information from 1 out of 3 credit institutes that collect information with respect to your payment history. These credit bureaus are Equifax, Experian and Transunion. Based on one of your reports, a computer system generates a number and gives your credit score. The number can be as high as 850, indicating a perfect score. On the other hand, it can plummet to 300, indicating you have terrible credit.
However, there are different aspects of your credit score. FICO’s algorithm is tuned to churn out your mortgage score, bankcard score, auto score and several similar scores. Also keep in mind that a score in any of these classes may vary depending on the bureau which originated it. For example, your Experian score may be different than your Equifax score.
Factors Impacting Your FICO Score
There are 5 factors that affect your FICO score. They are discussed below:
This accounts for a whopping 35% of your score. It is natural and intuitive that the best indicator of whether a person will be able to pay their bills on time in the future is how good their track record is with respect to past payments. The best credit scores are usually backed by a long and sound history of timely payments. This implies any missed or delayed payments, including collection accounts, delinquencies, adverse judgments and similar derogatory remarks, will hurt your credit score. However, they will not haunt you forever, as they fall off after the seven-year period.
To your dismay, paying for rent, utilities and other bills has no impact on your credit score. They are not considered trade lines according to FICO. The takeaway for you is that you should always pay your bills on time. It is ideal, especially in the case of credit cards, that you completely pay off your balance on a monthly basis to avoid interest.
This category accounts for 30% of your credit score and is complex to some extent, and stirs up considerable confusion when discussed. Also known as credit utilization, it comprises the following sub-variables in different amounts:
- The aggregate credit amount available vs. the aggregate of balances on revolving accounts
- The credit amount which is available on a revolving account vs. individual balances
- Total amount owed
- Number of accounts you are using
Your rate of utilization is computed in light of the most recent reports from your bank or other financial institutions. As most credit institutions and banks nowadays regularly report your balances to the bureaus, you can be rest assured that only your latest statement balance was used to calculate your FICO score. You should note that utilization is not a metric that has a history, so there is no such thing as average utilization. In other words, it is just a snapshot of various liabilities, which can soar or crash in just a month or even less.
Therefore, it is advisable to ignore utilization until 1 or 2 months prior to applying for a fresh credit line. Usually, if you have breached your credit limit by 30%, the lender will assign you a higher risk rating. A statement depicting 30% utilization will negatively affect your FICO score until you report a lower balance, but don’t worry as this issue is transient. So, it is downright logical and simple, pay your debts and keep balances low and you will have a higher FICO score.
Length of History
This class makes up 15% of your score and takes into consideration, among various details, the following information:
- Age of the oldest line of credit
- Age of the newest line of credit
- Average age of your accounts
If you take a moment to consider, it is straightforward that the longer you manage credit, the more experience you accumulate in terms of making timely payments and handling financial institutions as a result, you will be viewed as less of a risk. All lines of credit, closed as well as open, will contribute to your average age of accounts. Closed accounts have the potential of impacting your average age of accounts for up to 10 years.
Types of Credit
This category accounts for 10% of your score. Consumers have the luxury of benefiting from a diverse combination of accounts. Using a mix of revolving credit and installment will strengthen your score slightly, as the lenders are aware that you are familiar with various kinds of trade lines. However, remember that it is not mandatory to take out a loan just to strengthen this class. In some cases, it can actually be detrimental. Credit cards act as a good tool for building your credit history, but do not take out a loan just for the purpose of boosting your score.
This category makes up for 10% of your score. FICO contends that, with the use of statistics, consumers who are seeking out huge amounts of credit over a relatively short time period have the tendency of being riskier. To some extent, this is reflected in your FICO score, which is expected. When you request for credit extension, it triggers a hard inquiry in most cases. Hard inquiries, on their own, should not be a big cause of concern. Your credit score will not take a hit of more than 5 points in case of a hard inquiry.
This inquiry will have an impact on your FICO score for 1 year, and usually falls off the report after 2 years. Just make sure you do not trigger many hard inquiries in a short time span. At times, for informational and general purposes, some credit institutions extract your credit report without the intention of extending your credit, which results in a soft inquiry. Although soft inquiries appear on your report for a maximum of 2 years, they have no impact on your credit score and lenders ignore them. A soft inquiry will not be considered a credit-seeking activity, as you have not applied for credit.
Credit Misconceptions and Myths
Not Using a Credit Card Will Damage Your Score
This is a little tricky to examine honestly, as it entails a number of half-truths. The first one being that 0% utilization on all your revolving accounts does not look good for the month. But this is a trivial issue as we have already discussed that utilization only takes into consideration the latest reports.
The next truth is there are times when banks close accounts that have been dormant for about 6 months. In case it is one of your multiple credit cards, closing it down will reduce your available credit, which will increase your utilization thereby triggering a decline in your score. Before you allow your card to go dormant, it is recommended you check your terms just to be sure. Apart from this, a dormant but open card will not impact your FICO score either way.
It Is Important To Have a Balance and Pay Interest on the Credit Card to Develop Trust with Banks
This is definitely a myth. This has been busted some time ago, so we will dismiss it without delving into the details.
It Is Necessary to Utilize A Specific Percentage of Your Credit Limit Each Month
Remember this credit utilization adage which really matters: the lower, the better. Best credit scores tend to have utilization rates ranging from 1% to 9%. To remind you again, utilization has no memory and is a transient concept. As a result, it is really pointless to spend below or above a specific amount to secure a high score in a month when you are not even applying for new credit. So, the lesson here is simple, which is to concentrate on your regular expenses, and paying your statement in full each month.
Checking One’s Own Credit Will Impair the Credit Score
If a person checks his own credit, FICO recognizes that the person is not seeking new credit. Therefore, do not worry when you check your credit as it will not reduce your FICO score. In the same manner, numerous monitoring systems, such as Quizzle and CreditKarma, are soft inquiries and the same can be said about cards, which provide free FICO scores along with their monthly statements. So, we emphasize the real risk lies in situations where FICO tries to quantify the credit-seeking activity. Therefore, if you are not signing up for new credit lines, you have no reason to fret about your FICO score.