What Is A FICO Score and Why Is It Important?

It is the nature of humans to always want to know the score. Scores have always been important to those who use them to gauge their progress in life, whether it was a spelling test or the latest round of golf. However, no score is more consequential to us than our credit score, at least from a financial perspective. The difference between a good and an excellent credit score could mean tens of thousands of dollars in interest costs or simply being able to obtain financing. The ultimate score, and anyone who wants to know where they stand with their credit situation, is your FICO score.

The FICO score, developed by the FAIR Isaac Company more than 30 years ago, is the primary measure used by lenders to determine your creditworthiness. To this day, its formula for calculating your score is a closely guarded secret. However, based on years of study, we have determined the key criteria used in the scoring and their approximate weighting. Essentially, it breaks down as follows:

Payment History: This is your record of payments for as long as you have had established credit. The most important considerations are delinquencies and their severity, amounts past due, and the number of past due items, all versus the number of accounts paid as agreed.

Outstanding debt: This consists of analyzing amounts owed on your various accounts, including the number of accounts with balances and the number of credit lines used (especially with revolving accounts and installment accounts). The key factor is the ratio of total balances to the available credit. A high ratio is an indication of an over-reliance on credit.

Length of credit history: Essentially, the longer your credit history, the better. It is also important to show a continuous use of credit.

New credit: Opening a lot of new credit accounts within a short period of time can be hazardous to your score. Even a simple inquiry by a prospective lender to the credit bureaus can hurt your score.

Mix of credit: If you have too much credit with certain types of accounts, such as credit cards or installment loans, it could weigh against you. It is essential to have a broad mix of credit accounts.

Your FICO score constantly changes. With each activity – a payment or non-payment, a new account, a credit limit increase, or a sudden increase in your debt – the score fluctuates up and down. It never stays the same, which is why you should review your score frequently, especially if you have plans to apply for new credit.

Not all Scores are Created Equally

Most consumers are aware that they can order their credit reports for free from each of the three credit bureaus, and with the report comes a credit score. However, it is essential to note that those scores differ from your FICO score. Although, at one time, the credit bureaus purchased credit scores from FICO, which meant everyone was on the same page, they have since come up with their own scoring systems as a way to cut out the middleman (FICO) and make their own money on credit scoring.

While the credit scores from the credit bureaus are mainly based on the same factors and criteria as FICO, the specific formulas and algorithms used to calculate the score are very different. These scores can help educate you about your credit situation and help you track your improvements, but most lenders still rely primarily on your FICO score in their evaluation. So, when you are ready to apply for credit, order your FICO score at myFICO.com.

The bottom line is that you are being weighed and measured daily with every charge, new account, or payment. And the fact that a 20-point difference in your score, in either direction, can translate into savings or cost of thousands of dollars over your lifetime, your FICO score is, by a considerable measure, the only score that really counts.