What are FICO Scores and How Do They Affect U.S. Consumer Credit?

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FICO scores are a type of credit score that is widely used by lenders when assessing credit risks for consumer borrowers. While not usually the only factor, FICO scores weigh heavily on almost every kind of consumer credit decision including mortgages, credit cards, auto loans, and even store credit cards.

The History of FICO

The Fair Isaac Corporation first introduced the FICO score in 1989. It is a statistical analysis of a person’s credit file. The purpose of the score is to determine the creditworthiness of a potential lender.

It was designed as a way to save lenders time and to make credit decisions fairer, more accurate, and more efficient. This statistical approach allows a score to be quickly calculated and allows a lender to instantly get an idea of the risk posed by a potential borrower.

While there are several different competing consumer credit scoring systems, none of them have the authority and acceptance of the FICO score Currently, the American credit bureau Experian has an agreement with FICO to be the exclusive distributor of the FICO score.

What Factors Go Into Calculating a FICO Score?

FICO pulls credit data from all three major credit reporting agencies, also known as credit bureaus. These bureaus are Experian, Transunion, and Equifax.

The FICO uses a weighted system to look at five different factors. The factors are weighted differently for each individual, depending on several proprietary algorithms. However, it is generally believed that FICO weighs these five factors as follows:

  • Payment history 35%
  • Accounts owed 30%
  • Length of credit history 15%
  • New credit 10%
  • Credit mix 10%

The income of the borrower is not considered by the FICO score, but can be considered by individual lenders.

FICO Score Ranges

FICO scores can range anywhere from a low of 300 to a high of 850. A score of 850 is considered a perfect score. Generally, any score above 650 is considered a very good credit score. A credit score of 750 or above is considered a premium score and will qualify a borrower for the best interest rates available.

However, a borrower with a score of 620 or below will have a difficult time securing any credit.

As a general rule, the lower the FICO score the lower the borrowing limit will be and the higher the interest rate will be and the higher the FICO score the higher the borrowing limits and the lower the interest rate.

Dynamic Scores

FICO scores are dynamic. Because they are based on data from credit reporting agencies, any error on a credit report can cause havoc with a borrower’s credit score. One of the best practices for an American borrower is to first order his or her credit reports and review them for accuracy before having their FICO score calculated by a lender.

If a borrower has a low score, they are able to raise their score by improving their payment history, lowering the amount of outstanding debt they have, and waiting a while before opening new lines of credit.

Because the FICO pulls data from the credit bureaus, when a bad credit event like a late payment ages out of the period that the credit bureaus examine, it can lead to an increase in a borrower’s FICO score.

 

By Jason McBride

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