What is FICO? The Influential Credit Scoring Model that Can Determine Your Approval For Financing 

If you’re like me, being judged fairly and objectively is important to you. That includes how a potential lender might assess an application for a loan or credit card. For this reason, credit scores are incredibly valuable. 

They’re a record of how you manage debt and credit, and the main factor in determining whether or not you’ll qualify for that loan.

FICO, a company headquartered in San Jose, California, produces the most well-known and broadly used credit scoring product — the FICO Score. 

A wide span of financial institutions depend on FICO scores to understand their true risk level in lending money. Therefore, these numbers have a direct impact on eligibility, credit limits, loan amounts, and the attached interest rate. 

Since FICO scores are based on your past and current credit history, they will fluctuate depending on how you manage accounts and debt. That means you have control. If your score isn’t where you want it to be today, you can take action to make it better in the future.

Just as you and I want to be judged correctly, banks, credit unions, finance companies, and credit card issuers want to make the most accurate lending decisions possible. FICO scores help them achieve that goal. 

Instead of having to review your entire credit file to gauge lending risk, which can be a subjective process, the financial institution can check your number to know if you qualify. If you do, it can also use the score to set the terms of the loan.

FICO transforms your past and current account and debt data into a score between 300 and 850.

FICO scores are based only on the information that appears on your consumer credit reports. FICO has developed an algorithm that predicts how you will handle debt and accounts in the future. 

In short, FICO transforms your past and current account and debt data into a score between 300 and 850. Higher numbers are preferable because they predict less lending risk, while lower numbers predict greater risk.

Want to borrow money without it costing you too much? Create and maintain a high FICO score! Almost all credit issues will check your scores to see if you qualify for their product after you apply. 

If your scores are high enough (and you have met other criteria, such as income, basic expenses, and payment history), the lender will grant you the credit card or loan. Your FICO scores also affect the interest rate that the lender will attach to the account, so the higher those numbers are, the lower the interest rate will likely be. 

It may be frustrating to know that most credit card issuers do not specify the exact credit score you need to qualify, though. Instead, they typically publish that the card is appropriate for people who are within a credit rating range. 

FICO Scoring ranges are: 

If a credit card advertises that it would be an appropriate fit for people with fair credit, your credit scores also need to match. But other factors are considered, such as if you have defaulted on a loan in the past five years or your credit history is limited. 

Be aware that your FICO score can also impact the terms of your existing credit cards. The issuer granted the card to you when you qualified for it, but if your scores are much lower now, the company can react by lowering your credit limit. Conversely, if your scores rise, you may get notice that your credit line has increased. 

There are three major consumer credit bureaus in the United States: TransUnion, Equifax, and Experian. These private companies collect data from lenders, collection agencies, and the courts, then compile it all into reports. 

Because there can be variances between the information that is listed on each of your credit reports, your FICO scores may be different among them. For mortgage approvals, a lender must pull reports from all three credit bureaus, but if the scores differ, it will use the median score. If one score differs, the lender will go by the two matching scores. 

Each month, FICO will pull the data listed on your credit reports and input it into its mathematical model. There are four sections of a credit report, but only three are used for credit scoring purposes. They are:

• Trade Lines. This is where your current and past credit cards, loans, and any collection accounts will appear. It will show your payment history, the date the account was opened, and your current debt. For revolving credit products (like credit cards and lines of credit), it will indicate the amount owed and the credit limit. Loans will indicate if they have been satisfied or if a debt is still outstanding. Because this section comprises the most important information to a lender, it carries the greatest scoring weight. 
• Inquiries. If you have applied for any credit product, it will show up as a hard inquiry on your credit file. Although these inquiries can stay on your credit report for two years, FICO Scores only input those from the previous 12 months. Soft inquiries will appear too, but are not included in your score because they do not necessarily mean you’re applying for credit. A lender may have checked to see if you prequalify for a credit card, for instance.
• Public record. If you have filed for bankruptcy, it will appear in the public record section of your credit report. Chapter 7 bankruptcy will remain on your report for 10 years from the filing date, while Chapter 13 bankruptcy will stay for seven years from the filing date. 

Personal identification information will also be on your credit report but is not inputted into your FICO scores. 

In addition to making sure that the information on your credit report is positive, check your reports for accuracy. You don’t want to be penalized for mistakes or fraud. For instance, if you paid a debt in full but it is still showing that you owe money, your score will be negatively impacted. 

Dispute any false or inaccurate information so it is not held against you.

FICO scores come in variations for different purposes. The FICO 8 model is for general lending decisions, but mortgage lenders use a FICO Score for home loans. Auto finance companies use the FICO Auto Score, while the FICO Bankcard Score measures creditworthiness. 

As a consumer, you can access your FICO Score directly from FICO, but also from the credit bureau Experian. Your credit card company may also provide you with your FICO score. However you access it, it’s good to keep an eye on the numbers. If they swing high, you know you’re on the right track.

If your scores fall, however, it’s an indication that something is amiss. It should be a prompt to review your credit accounts (maybe you forgot about a credit card payment) or check your credit report for free at AnnualCreditReport.com to find out if there has been an error.

Although the name implies you can only check it once per year, you can actually view all three of your credit reports as often as every week. AnnualCreditReport.com does not provide credit scores, but you can get full copies of all three of your credit reports to see the factors influencing your FICO scores.

Whatever the case, the sooner you approach and clear the problem, the faster you can offset more credit scoring damage. 

Also, you should know that FICO isn’t the only credit-scoring company. VantageScore was developed by the credit bureaus and is becoming popular, and many free credit checking services will give you your VantageScore rather than your FICO score. You won’t know or have any control over which credit score a lender uses, but a good general rule of thumb is that if your FICO score is good, the others will be too.

FICO does not publish the exact algorithm that it has created, but does provide an overall explanation as to how the score is determined. There are five factors, each with different weights. Some are within your control while others are not. 

Payment History: The Biggest Factor

A whopping 35% of your FICO score is about how you have paid your accounts. It includes a detailed monthly payment pattern, indicating whether you’ve made payments on time or whether you’ve fallen behind.

If you are very late, the lender will write the account off as a loss. That, too, will be indicated on your credit report and factored into your score, as will accounts that have been taken over by third-party collection agencies. 

Negative information like this will stay on your reports for a total of seven years. However, recent information is weighted heavier than older information. Therefore, if you missed a loan payment six years ago, it will have far less impact on your FICO score than if you were late six months ago. 

The good news is that payment history is mostly within your control. As long as you make your payments on time, which typically means that you have not skipped an entire payment cycle, your credit scores will greatly benefit. 

Credit Utilization: How Much You Owe

The amount of money you owe on accounts comprises 30% of your FICO score. What is most important is your credit utilization, which is the amount of debt you carry on credit lines compared to the credit limit. Less is best.

When you owe a large portion of your credit line, the perception is that you are more likely to fall behind because you are overextended. 

FICO considers the amount you owe on all accounts, how much you owe on different types of accounts (such as credit cards and loans), the number of accounts that have balances (fewer is ideal), and the credit utilization ratio on such revolving accounts as credit cards. 

You will want to owe nothing or very little on credit cards, both per account and in total. To ensure that this scoring factor is working in your favor, keep track of how much you owe each month and stop charging before the balance is too high to repay in full by the due date. 

As for installment loans, you will be paying the principal over time, and that will work to your scoring benefit. 

Length of Credit History: Time Matters

The length of your credit history is 15% of your FICO score. The more years that you have proven that you are a responsible borrower, the more your score will benefit. 

This scoring category evaluates the length of time that you have had credit accounts. It takes into consideration the age of your oldest account, the age of your newest account, and the average of all.

How long specific credit accounts have been open is also a factor. 

To build and maintain a long credit history, start soon. If you don’t qualify for a good unsecured credit card now because you haven’t used credit products yet, look into a secured credit card.

Qualification for a secure card depends on the security deposit you put down, so they’re perfect for credit newbies.

Then, keep older accounts active. New accounts dilute the length of your credit history and can shave some points off your FICO score. However, as long as you treat the accounts well, in time your score will recover. 

Credit Mix and New Credit (10% Each)

The last two FICO Credit scoring categories are credit mix and new credit, both of which comprise 10% of your score. 

Although minor compared to the other credit scoring categories, they can still have an impact. 

FICO looks at the mix of credit you have, as well as your payment history for each. A healthy mix might be a combination of credit cards, store cards, home equity lines of credit, and various installment loans.

Pay all on time and in full, and your scores can get an extra kick. 

As for new credit, hard applications (inquiries) will be factored in. Although you have to apply for an account to get it, be prudent.

Opening multiple new credit accounts in a short span of time is considered risky, especially if you don’t yet have a long credit history, which can result in a lower score. 

If you’re in the market for a loan or credit card and want to know if you qualify before you apply, check to see if the lender has a pre-qualification program. If so, it can help you know if you might be eligible for the account. 

The fact is, your FICO score has a direct impact on your financial opportunities. Whether you want to take out a great new credit card or finance a car, home, or personal project with an installment loan, these three-digit numbers will be important. They give the lender the ability to make near-instant decisions. 

If your credit scores are in the excellent range, you are considered a very low-risk borrower. Therefore, the array of accounts that are within reach will be robust. Credit cards will likely come with the lowest interest rates, as well as the best benefits and perks. Loan limits may be high and interest rates low.

Getting Approved for Credit Cards and Loans

Don’t panic or become distressed if your credit scores are currently in the bottom ranges. You still have options!

You may want to begin with a secured credit card. These cards require you to put down a deposit in advance, which the lender takes if you fail to pay your debt. This means they aren’t losing money if you default, so there’s less risk involved.

When you charge often but keep the balance to zero or extremely low, you will build your credit scores. The issuer may also release the funds held as security. 

Here is a chart that details some of the differences between unsecured and secured credit cards:

Keep track of your credit score. When it edges up toward the good range, check out the credit cards that are available. They may have excellent rewards programs and other perks that can make your life easier and less expensive. 

As for loans, don’t count those out when your scores are low either. Federal student loans do not check credit scores for approval, so if you are in college and need to finance your education, you can borrow what you need. Loans that are small or secured are also ways to start borrowing. 

Some credit unions offer credit builder loans, which are designed to help people establish or build their credit histories and credit scores. They are usually small sums and have terms between six and 24 months. After paying off the balance, you get the money — and the positive credit history that comes after making all the payments on time. 

Effect on Interest Rates and Terms

Not only does an excellent FICO score translate into easy and vast credit approvals, but it also keeps costs down.

A credit card issuer may charge you the highest interest rate when you get a card with a low FICO score, but that rate will be irrelevant if you always pay the account in full by the due date. That’s because the issuer will not add interest during the grace period, which is typically 25 to 30 days. 

However, interest will not be avoidable when you take out loans. The lender may charge you a much higher interest rate when your FICO score is very low. The impact is especially profound for large, long-term loans like mortgages. 

For example, imagine you are purchasing a $400,000 home with a 30-year term mortgage and can put 20% down. If your FICO scores are very high, you may qualify for a 6.00% interest rate:

• Monthly payment: $1,918.56
• Total interest paid:  $370,682.20

On the other hand, if your FICO scores are very low, the interest rate you qualify for may be 7.5%: 

• Monthly payment: $2,237.49
• Total interest paid: $485,495.11

With a low score, each month you will be paying $318.93 more, and $114,812.91 more in total financing fees. That’s a huge difference in cost.

As you can see, FICO scores are a crucial element in the lending process. The higher they are, the more opportunities will be open to you. 

And while powerful, FICO scores are under your control. When you treat credit products in just the right way, those numbers will work in your favor — fairly and accurately.