What is a FICO score, How is it calculated and How can you improve yours

If you are looking to obtain any source of lending, chances are the lending institution is going to run your credit report.  Now, here at this website we don’t look kindly upon lots of debt, however, sometimes it is a necessary evil, such as when you want to buy a home.  Most individuals and families cannot pay for a house with cash (although it would be nice!).

A FICO score is a credit reporting score, invented by www.myfico.com.  FICO scores are your “credit rating” based on many factors, to be named later.  The score ranges from 350 – 850 and higher is better, with a perfect score being almost impossible to achieve.  Most lenders base their approval of a loan on this score, which means it is imperative to understand what the score means, how to improve your score, and how to retrieve your score on your own.  According to their website, myfico.com states they are the only site offering all 3 of your FICO scores.  The three primary credit rating agencies for your score are Experian, Equifax, and TransUnion.  The median FICO score in the U.S. is 723.

A FICO score considers: Payment History, Amounts Owed, Length of Credit History, New Credit, and Types of Credit in Use.

Examples of reasons why your FICO score may have decreased:

• Missed payments – any missed payment, no matter what the dollar amount, could negatively affect your credit score. Remember, that $40 utility bill means just as much as your mortgage payment! Your payment history makes up the largest part of your FICO score and the longer you pay your bills on time, the better your score will be.
• Comparing scoring formulas – I made this mistake the first time I pulled my credit report. Each scoring agency has their own formula, and some are based upon different metrics. Over 80% of lenders use FICO scores as part of their decision-making process, so make sure you are comparing a FICO score with a FICO score, and not another reporting agency score.
• What are the negative factors on your report - When you read your report, it will point out specific areas which negatively impacted your scores. Read and analyze these factors, and improve upon them.
• Closing credit card accounts, increasing balances, and decreasing limits - all negatively affect your score. Yes, closing a credit card negatively impacts your score. I have no idea why, but it does. I guess the theory is that the more credit you have available to you, the better off you are (which I do not agree with, but oh well!).
• New account opening - has the same effect as closing a credit card – go figure! Opening a new credit account may be an indication that you could be higher risk and thus may reduce your score.

How to increase your score (from myfico.com):

• Pay all bills on time.
• Focus on negative factors on prior credit reports.
• Apply for new credit only when necessary.
• If you miss a payment, get current and stay current ASAP.
• If you don’t think you can get yourself out of your credit issues and are having trouble paying your bills, seek a credit counselor and/or financial advisor.
• Keep balances low on credit cards.
• Keep balances low on revolving lines of credit.
• Pay off debt; don’t shuffle credit from one account to another.
• Past credit problems? Re-establish your history by responsibly opening new accounts and paying them on-time, all the time.
• Do your rate shopping for a loan (i.e. home mortgage) within a focused period of time.
• Don’t close unused credit cards.
• Don’t open a number of new credit cards that you don’t need just to increase your available credit.
• If you have been using credit for a short time, don’t open a lot of new accounts too quickly, as this could negatively impact your score.

As stated previously, debt can be evil, but certain loans can be your friend, if managed properly.  This needs to start early in life, i.e. your first credit card, however, don’t ever think that it is too late to sure-up your credit.  Just think about when you want to purchase your first (or second or third) home someday!