For the average consumer the concept of the FICO score is foreign. When one is first introduced to FICO it almost seems like a strange cultural concept, primarily because consumers do not develop their spending, or financial decisions around FICO scores.
Very few consumers teach their children about FICO, nor are there FICO classes in school. Most of us learn about FICO when it has become an obstacle, the enemy if you will, to buying a car or investing in our first home. Some here about credit scores from television commercials, but the importance of the FICO score is rarely talked about.
The first step is to learn what the FICO score is, then how it is determined and finally, how it can affect the actual costs of buying a car or a home. Rest assured as you read on, you will be provided some resources that will help you too. In the end you will be able to see how the FICO score really can benefit you.
What is FICO and what does it do??
FICO is an acronym for Fair Isaac Company, the company that developed the formula for determining credit scores in the 1950s. Since that time companies that grant credit to consumers have been using the score to determine the probability that a consumer will pay back their debt compared to other consumers. The standard for scoring is 300 being the worst score that puts you at the highest risk because you are not able to manager credit. 850 being the best score, or the lowest risk.
It is suggested that you shoot for 700 which is an acceptable score for most lenders. The higher your score the more sure you are getting the best rates and other opportunities that associate with the score. The FICO score is only part of the information that a creditor uses, but it does help speed up the process.
The formula is a mathematic equation based on information gather from a consumer?s credit report. Every consumer who pays bills has a credit report. Banks, credit card companies, and anyone who grants credit, periodically reports information to credit report agency. The lender buys the report from one or all of the credit reporting agencies to use that information to determine whether or not you are a good risk.
The three major credit reporting agencies are Experian, Transunion and Equifax. The FICO score is calculated based on the information in each report. Not every creditor reports to all three agencies, so each report may be different and therefore each agency may report a different number. There is no one FICO score, but the information collected from each report is standard.
- Payment history: 35% of your score is based on your payment history. This is one of the most important factors in the FICO report, but a few late payments won?t be the end of you. There is no guarantee that having no late payments will give you a perfect score because this is only one factor.
- The amount you owe: 30% of your score includes the amount of available credit that is used. This indicates that you may be overextended. In other words how much is too much? The amount owed as of your last statement is what shows up on your report. How much you owe on different types of credit also factors in.
- The types of credit accounts for 10% of your score. Consumers who have no credit cards are considered higher risk. Consumers with well managed different types of credit have are considered a lower risk. A closed account doesn?t go away. If possible you should keep a small balance on your cards.
- New credit is 10% of the score. Opening a few cards in a short period of time increases risk especially if you have a shorter history. Inquiries are important here. When you inquire or a lender inquire for prequalification or a current lender make an inquiry are pretty much ignored. New credit is a good thing if you are rebuilding your score.
There is much more information available at?myFICO.com. There is information that explains in greater detail how your FICO score can affect the rest of your life?forums for discussion?and blogs for even more information. There is information on credit products; so much information that it is impossible to discuss it all here. This website is also suggested by the federal government?s Consumer Financial Protection Bureau.
Information not found in your FICO score.
Race, color religion, origin, sex, marital status, and age, by law are in figured into your score. Salary, occupation, title, or employment history are considered along with other information. Your family obligations such as spousal or child support and residence as well as interest rates charged by other lenders.
How Does The FICO Score Affect How Much You Pay?
The FICO score is not the only measure lenders use to grant credit, but it can affect your interest rate. A higher interest rate increases the amount of money you pay overall. A lender may grant the credit but will charge the higher rate of interest to offset the risk. Below is an illustration for a 30 year fixed loan, using a national average interest rate, and a loan amount of $200,000.00. There is a substantial difference in monthly costs and total interest for different FICO scores:
Score Range: 620-639
Monthly Payment: $1,056
Total Interest Costs: $180,069.00
Score Range: 640-659
Monthly Payment: $991
Total Interest Costs: $156,603
Improving your score by 20 points can save?$23,466.00?over the term of the loan and $65.00 per month.
There is a greater savings as your FICO score increases:
- 660-679 reduces the costs by: $41,416.00
- 700-759 reduces the costs by: $57,319.00
- 760-850 reduces the costs by: $66,167.00
Here?is a?Loan Savings Calculator at?myFICO.com?where you can input your particular information such as a shorter term, variable rates, your particular location, etc. to get a better idea of your costs and savings. As a side note, the lowest scores the calculator will factor is 620.
Your FICO score is one of the most important numbers in your life. It not only determines financial standing but a lower score can cost you a higher security deposit for utilities or insurance. Some employers look at FICO scores when determining an applicant for employment. Property managers consider FICO scores when considering leasing applicants, your FICO score can help determine the kind of neighborhood you may live. A higher end development may turn you away if your FICO is low. In spite of those examples, the FICO should be considered an ally and should be used as a gauge in determining what financial decisions you make.
Consumer reports and commercials offering free credit reports often seem credit scores are shadowy monsters looming over your financial life when actually using the FICO score benefits all consumers. Along with the immediate and personal savings for consumers there are some other behind the scenes positive benefits:
- Consumers get loans faster: Mortgage decisions can be made within hours instead of weeks and other credit applications can be approved in minutes. This alone lowers the cost of extending credit; thereby lowering the interest rate overall.
- Credit decisions are more objective: There are no personal opinions involved, just the factual numbers. This leaves out race, gender and other things that have nothing to do with risk.
- Past credit mistakes count for less: The FICO formula factors in all of your history. As you accumulate positive payment habits the former negative habits count for less and eventually your score will increase.
- Lenders can offer more loans: Because the FICO stabilizes the process and allows for more products to be developed. A consumer may not get approved for ?instant credit? online or in a store, but there may possibly be a different package available. If one lender turns you down, another may approve.
- More available credit means lower rates across the board: The almost instantaneous results lowers the cost of lending and that reduction is passed on to the consumer.
Final bit of Information: Take Caution
Not every free credit score is a FICO score. There are many other companies that have their scoring system. It is important to know?that FICO is used by 90% of companies that buy credit scores to determine the risk of granting credit. Again, FICO is not the only consideration, but it certainly factors in a great deal toward granting the credit and it most certainly considers in how much the credit will cost.
It may be difficult to determine if a score obtained from another source is reliable until something happens. It would be a waste if your relied on the other scores only to find out there formula was flawed and that score not be accepted. Take the time to make your own inquiry at least once per year. Every consumer is allowed one credit report each year.
If after all of this you are not moved by the importance of a FICO score knowing what is on the report can help reduce the effects of or prevent identity theft. There are discussions and educational information shared by experts and the community at the myFICO.com forums.