How is a FICO Score Calculated?
Posted on June 25, 2009
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In the face of a worsening economy, would-be borrowers are having an increasingly difficult time getting approved for home and car loans. Although you can't control how the banks set their lending criteria, you can control how your credit score shapes up – and the first step towards improving your score, is learning how it's calculated.
Your credit score, referred to as a FICO score, is an indication of your creditworthiness; it's a simple three-digit number that will determine the amount you can borrow and the interest you'll pay.
FICO scores range from 300 to 850, and the rule of thumb is, the higher your FICO score, the better your loan approval conditions. A higher FICO score translates to higher lending limits and lower interest rates, so it's definitely a good idea to keep your FICO score looking as healthy as possible.
It's called a FICO score because the number is based on a formula developed by the Fair Isaac Corporation. They begin by looking at a summary of all your credit accounts, including mortgages, car and personal loans, store cards, and of course credit cards. The focus is on your repayment history: have you missed many payments, or made late bill payments? Do you have outstanding debts that you've never repaid?
Generally, a score above 700 is considered to be a good result. To achieve this, you need to make regular, on-time repayments on all of your bills; manage at least one or two credit cards, ensuring you keep your balances low; maintain high credit limits so that your debt-to-limit ratio appears strong; and regularly monitor your FICO score to rectify any incorrect transactions that are recorded.
Your score is calculated via a very specific formula, so keep this in mind next time you consider closing an account or reducing your credit card limit:
- 35% is based by your repayment history.
- 30% is based on your total credit card limits, as compared to your total debt balances.
- 15% is based on the length of your credit history – including the length of time you've had each account open, and the level of activity on each account.
- 10% is based on inquiry levels, ie. how many accounts you've recently opened or tried to open, compared to your total number of accounts.
- 10% is based on the various lending facilities you managed. How you handle revolving credit card debt, for instance, is weighted more heavily than a fixed debt and repayment system, such as a home loan.
Peter Carville is a freelance article writer who writes for Financial Facts about the current financial news and the credit crunch.
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