What’s a FICO Score, and why should you care?

via What’s a FICO Score, and why should you care? | Consumer Watch, clarionledger.com, 2/11/2013

In the days before banks and creditors could talk to each other easily, the decision to grant credit was in some ways a shot in the dark. Businesses and financial institutions took risks based on several factors, the primary one of which was your reputation, and whether you had collateral they could take if you defaulted on your obligations. Of course, to be successful, a bank had to be right more than wrong. Bad lending decisions meant you would likely lose money.

These days, most creditors and financial institutions play the numbers. Any potential customer is examined thoroughly (the bigger the loan, the more exhaustive the research). When granting credit, the biggest question creditors ask is whether you have the means (and the intention) to pay back the loan. And since lending rules have tightened considerably since the recession of 2008, it’s more crucial than ever to maintain your record of credit-worthiness.

The main tool creditors use to assess you is called the FICO score. FICO is an acronym for Fair Isaac Corporation. This business, founded in 1956 by an engineer named Bill Fair and a mathematician named Earl Isaac, has become the industry standard for determining credit-worthiness of potential customers.

FICO uses a complicated formula to determine how much of a risk you are. FICO delivers a numeric grade, ranging from 300 to 850. The higher the number, the better your chance of getting credit, and taking advantage of lower rates. The biggest piece of the score (35 percent) is your payment history. The three major credit bureaus (Transunion, Experian and Equifax) each keep their own records, and variants on the FICO system.

The biggest factor: payment history
The payment history is useful to creditors because it shows how you’ve paid your bills in the past. The score looks at…

How late they were. A consumer with more than a few bills paid late or defaulted will lose points.
How much was owed. The amount of the debt is taken into consideration. Consumers juggling a lot of debt may find it harder to stay current.
How recently they occurred. The further back in history late payments occurred, the smaller the impact.
How many there are. If there are many accounts paying late, you’ll lose points.

The bottom line: keeping your payments current will go a long way toward helping you maintain a good score. If you can, it’s also a good idea to pay down your debt, so there are fewer and the total amount is less.

In the next post, we’ll discuss the next biggest piece of the credit-score pie: the total amount of debt.

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