FICO credit scores are a number used to express how creditworthy an individual is. It is calculated using a formula developed by the Fair Isaac Corporation, hence the name FICO. After years of research, the Fair Isaac Corporation discovered that consumers who were likely to repay their loans had different borrowing and spending habits than those who were likely to default. Based on their discoveries, they decided that it would be valuable to the lending industry if every potential borrower were assigned a score that expressed how likely they were to repay a loan. They developed a mathematical formula to calculate a consumer's creditworthiness, and FICO scores quickly were adopted as a standard by lenders.
How is my FICO score calculated?
FICO scores are calculated using a complex formula that the Fair Isaac Corporation has trademarked and kept secret. However, the factors used in the formula are public knowledge. Anyone with a credit history has a FICO score. Scores generally range from 300 to 850. About half the people in the United States have a FICO score over 725.
The following factors are weighed to calculate your FICO score:
How each individual factor is weighted is unknown. Late payments and a high number of credit searches will have a negative impact on your score, as will an excessive amount of debt. Credit professionals recommend using around half of the credit available on any single card.
How FICO scores are used
Every time you apply for a credit card, a mortgage or any other type of loan, including auto and student loans, the lender will look at your FICO score. Banks, credit card companies and other lenders use your FICO score to determine whether they will lend you money and at what interest rate they are willing to lend it. In general, the higher (better) your FICO score, the lower the interest rate you will have to pay when you borrow money. If your FICO score is low, the lender may refuse to lend you money or may lend you the money at a relatively high interest rate.
FICO scores are also used by insurance companies in some states to determine what you will pay for auto insurance. Some employers will look at the FICO scores of job applicants and use the scores as a decision-making factor in the hiring process. Although the FICO scoring system was not designed to be used for these purposes, the reality is that it is being used by more institutions and for more varied purposes than it was ever intended to be. This makes it important to know your FICO score, to make sure it's accurate and to take steps to keep it as high as possible.
Finding out your FICO score
You can't get free FICO scores. While you are entitled to a free credit report from each of the three credit reporting agencies (Equifax, Experian and TransUnion), the credit score they provide isn't the same as your FICO score, and in some cases it may be as much as 100 points higher than your actual FICO score.
There are several online calculators that you can use to estimate your credit score. These calculators will tell you the range your score is likely to be in. However, if you will be applying for a loan soon, you should consider spending the money (about $50) that it will cost to view your official FICO scores.
Benefits and drawbacks of the FICO score system
The FICO score system has both good and bad points. On the plus side, since it is calculated based on known factors, it is simple (though not always easy) to raise your FICO score: just make your payments on time, decrease your debt and stop applying for or accepting new credit offers. On the downside, the FICO score system may cast an undeserved negative shadow on people with short credit histories, who will likely receive low FICO scores even if they are very creditworthy.
Although it is not a perfect system, the FICO score has been a part of the lending landscape since 1989 and it doesn't look like it's going away anytime soon. So your best bet is to learn to manage it, live with it and use it to your advantage.
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