FICO Score – How It’s Determined
Do you ever feel like you’re just a number? Well, in the eyes of lenders, you are a number, and that number is called your FICO score.
Despite the commercials on TV about wanting to make your dreams come true, most financial institutions are not interested in lending to you if you have a low FICO score. This number is being used by everyone from lenders and insurance companies to prospective employers to gauge your ability and willingness to repay loans as well as your trustworthiness. FICO scores are now being used by dating sites as they have been shown to be a good predictor of marital compatibility.
Your FICO score takes time to establish and a long time to repair.
Here is the approximate breakdown of how your FICO score is calculated:
- 35% of your FICO score is based on your payment history.
- 30% is based on the percentage of your credit capacity being used; i.e., the ratio of current credit debt in comparison to total available credit.
- 15% of your FICO score is determined by the length of your credit history. 10% is based on the types of credit you have; i.e., installments (car payments, student loans, or a mortgage), revolving (credit cards or lines of credit), and consumer finance (bank loans and the equivalent).
- 10% is based on recent searches for credit and/or the amount of credit you’ve recently obtained.
Although, the exact formula is a mystery, it is believed that your FICO score starts to decline once your total balances exceed 35% of your total revolving credit limit. It is advisable to ask your credit card company to raise your limit in order to keep your average use under 35%. Do not wait until your card is maxed out to ask for a higher limit. For some strange reason, banks and credit card companies are most willing to lend when you don’t need the money.
I would also advise you not to apply for new credit immediately prior to or during your application process for a home loan. When you get new credit, your FICO score will dip between 5 and 50 points. All lending institutions have a credit monitoring system in place that notifies them if an applicant is establishing new credit accounts while in their underwriting process.
A lot of borrowers don’t want lenders pulling their credit since they fear their scores will decline. However, if you have multiple requests for one type of credit within a short period of time, such as a car loan, it will only count as one inquiry.
Our recommendation: Establish great credit and then use it sparingly. Frequent flyer miles are great, but you better be able to pay your bill in full each month. Otherwise, the wealth-maximizing strategy is to pay cash.
For More on this topic, check out this article from WalletHub: FICO Score: Range, What’s Good, Free Options
Have a great week.