A FICO score is a numerical score used to determine credit worthiness. Banks and lenders use it to assess credit risk.
The name is an acronym for “Fair Isaac Corporation” and was founded in the late 1950’s by William Fair and Earl Isaac in Marin County, California. It became a publicly traded company in 1987 and relocated to Minneapolis, Minnesota in the early 2000’s.
Although it is not the only numerical method of determining borrower credit worthiness, it was among the first to gain wide-spread acceptance and continues to be the most well-known.
Before its wide-spread use, credit risk was assessed by on a case-by-case (or borrower-by-borrower) method that was criticized for being uneven and potentially discriminatory. Since the FICO scoring method uses five basic factors to determine a borrower’s credit, other personal factors such as age, race, type of employment, and marital status do not come into play.
The five factors are:
- Payment History: This accounts for around 35% of the FICO score and examines items such as ability to pay debts, history of paying on time, and any delinquent or “past due” accounts.
- Amounts Owed: The second highest portion of your FICO score at 30%, this takes a look at how much you owe in relation to available credit, number of accounts, and account balances.
- Length of Credit History: 15% of your FICO score looks at how long you have been borrowing (and hopefully, repaying) your consumer debt. Inn most cases, the longer the better!
- New Credit: New or recent credit lines opened accounts for 10% of the FICO score. It is used as an indicator of how much new debt (and, therefore, with a rather unpredictable history) you have.
- Type of Credit: FICO scores like to see a diversity of credit on your credit report. This factor accounts for 10% of the overall FICO total score. Credit lines such as credit cards, mortgages, auto, etc., show a willingness and ability to handle diverse types of debt and payment arrangements.
The FICO scoring method has come under criticism lately because, as borrowers and lenders learn more about how the scores are calculated, it is assumed the results can be skewed one way or another.
However, most lenders – certainly most home mortgage lenders! – still use the FICO scoring method as a way to determine who and how much money they are willing to lend.
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