Contrary to what some believe, FICO is not associated with the government. FICO stands for the Fair Isaac Corporation, the company that created the formula for the FICO credit scores. The Fair Isaac Corporation was found in 1956 by engineer Bill Fair and mathematician Earl Isaac.
While Fair Isaac Corporation created the FICO Score formula, the company itself doesn’t engage in calculating consumer credit scores.
In order to actually calculate a FICO Credit Score – one needs credit information and history, which is where the three credit bureaus come into the picture.
A FICO score ranges from 300 to 850, with the majority of Americans falling between 650 and 750 (See Average Fico Score for more information). It takes into consideration 5 factors:
The most important thing to understand about Fico score rating (or any other score) is that negative items have much more impact (i.e. lowering your score) than positive items do.
Try to imagine it like a few drops of black ink in a glass full of pure water. A few bad items such as late payments can do a lot of harm to an otherwise clean credit history.
Here is a breakdown of the FICO Score formula:
Your Payment History contributes approximately 35% to your FICO score. Any negative information such as charge offs, collections, late payments, repossessions, foreclosures, settlements, bankruptcies, liens or judgments against you lowers your FICO score. The severity of each item is determined according to theses 3 rules:
- Newer is worse than older.
- More severe is worse than less severe.
- Many are worse than few.
- Revolving Debt such as Credit Card debt, Gas Station cards and Retail credit cards debt.
Revolving debt is considered risky because it is usually unsecured debt, and therefore receives more weight in the formula. As a rule of the thumb – try to keep your revolving credit utilization below 35%.
- Installment Debt is a debt where you make fixed payments for a fixed period of time (e.g. an auto loan). Since most Installment debt are secured by an asset (e.g. your car), you are more likely to make a considerable effort to keep the payments. Installment debt is therefore considered less risky and receives less weight than revolving debt in the FICO score formula.
- Open Debt is a debt that must be paid in full every month (e.g. American Express Green). Not so common these days, this type of debt is considered the same as revolving debt in the older versions of the FICO score formula, but excluded from your revolving credit utilization in the new FICO score versions.
A side note: closing unused credit card accounts in an attempt to raise your FICO score is a bad idea. Closing the accounts will reduce your total available credit limits and will actually increase your credit utilization percentage – hurting your credit score.
Length of your credit history (Credit File Age) contributes approximately 15% to your FICO score. In general, the older (and stable) your credit report is – the better it is for your FICO score. The credit file age is determined in two ways:
- The oldest age on your credit file: is set by the oldest “Date Opened” of your accounts.
- The average age of the accounts on your credit file: is set by averaging the age of every account on the credit report, either open or closed.
Account Diversity contributes approximately 10% to your FICO score. Having a diverse set of account types on your credit file (installment, revolving, auto, mortgage, credit cards, etc.) is actually a good thing and will benefit your FICO score, because you’re proving the ability to manage different account types.
Hard inquiries (made by lenders looking into your credit report when you’re seeking new credit or a loan) may or may not affect your FICO score. In general, many inquiries over a short period of time on your credit report may be a signal that you’re in financial difficulties, and may lower your score.
See FICO Score Formula for a list of factors that DON’T hurt your score.
Three Versions of FICO Score Rating:
Each of the 3 major credit bureaus has branded their FICO credit score with different names.
- Equifax calls its version of the FICO – BEACON credit score.
- Experian calls its version of the FICO credit score the Experian/Fair Isaac Risk Model or Score Power.
- TransUnion calls its version of the FICO credit score EMPIRICA.
On January 2009 Fair Isaac has updated the Classic Fico formula and introduced the NexGen FICO or FICO 8.
The three major credit bureaus have also re-branded their private versions of the NexGen FICO accordingly:
- Equifax calls its version Pinnacle.
- Experian is using the name FICO Advanced Risk Score.
- TransUnion uses the name Precision.
Experian no longer uses the FICO credit score system. Instead, it is using the Vantage Score solely. This means that not only you can’t get a FICO score directly from Experian, they don’t allow myFICO.com to provide customers a FICO score based on their Database!
Lender continues to use Experian based FICO scores, but as a consumer you no longer have access to it.
See Understanding Fico Scores for more information about the different versions of the FICO score. See also What Are Good Credit Scores to learn about the impact of your credit score on your financial life.