The History of The FICO Score
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Credit scoring is an important part of the lending process. It helps lenders to evaluate the risk of lending money to individuals, and it helps individuals to understand their creditworthiness and improve their credit score over time. One of the most widely used credit scoring models is the FICO score, which is named after the company that created it, the Fair Isaac Corporation. In this blog post, we will explore the history of the FICO score, how it is calculated, and how it is used by lenders.
The Origins of the FICO Score
The history of the FICO score can be traced back to the 1950s when Bill Fair and Earl Isaac founded Fair, Isaac, and Company. The company initially specialized in data analysis and consulting, but it soon turned its attention to credit scoring. In the 1960s, Fair and Isaac created the first credit scoring model, which was used by credit bureaus to evaluate the creditworthiness of individuals. The model used a variety of factors to determine a person’s creditworthiness, including their payment history, outstanding debt, and the length of their credit history.
Over time, Fair and Isaac refined their credit scoring model, and in 1989, they introduced the FICO score. The FICO score used a scoring range of 300 to 850, with higher scores indicating better creditworthiness. The score was based on a person’s credit report, which was maintained by the three major credit bureaus: Equifax, Experian, and TransUnion.
How the FICO Score is Calculated
The FICO score is calculated using a complex algorithm that takes into account a wide range of factors. The exact algorithm is not publicly disclosed, but the general factors that are used in the calculation of the FICO score are well known. These factors include:
The payment history is the most important factor in the calculation of the FICO score. It accounts for 35% of the total score. The payment history includes information about whether a person has paid their bills on time, how late they were with their payments, and whether they have had any delinquencies or bankruptcies.
The amounts owed account for 30% of the total score. This factor takes into account the total amount of debt a person has, as well as the type of debt they have. It also looks at the percentage of available credit that is being used. People with high credit utilization ratios are generally considered to be at a higher risk of default.
Length of Credit History:
The length of credit history accounts for 15% of the total score. This factor looks at how long a person has had credit, as well as how long they have had each credit account. A longer credit history is generally considered to be a good thing, as it shows that a person has a track record of responsible credit use.
Types of Credit Used:
The types of credit used account for 10% of the total score. This factor looks at the different types of credit that a person has used, including credit cards, loans, and mortgages. A person with a mix of credit types is generally considered to be a better credit risk than someone with only one type of credit.
New Credit Inquiries:
New credit inquiries account for 10% of the total score. This factor looks at the number of times that a person has applied for credit in the recent past. Too many credit inquiries can indicate that a person is at a higher risk of default, as it suggests that they are looking for credit to support their lifestyle.
How the FICO Score is Used by Lenders
The FICO score is used by more than 90% of top lenders in the United States to make credit decisions. When a person applies for credit, the lender will request their credit report from one of the three major credit bureaus and use the FICO score to determine whether or not to approve the application. The FICO score also plays a role in determining the interest rate and credit limit that the borrower will receive.
The FICO score is particularly important for borrowers seeking a mortgage. In the mortgage industry, lenders use a version of the FICO score called the FICO Mortgage Score, which places greater emphasis on factors like payment history and amounts owed. A high FICO Mortgage Score can help borrowers qualify for a lower interest rate, which can save them thousands of dollars over the life of their mortgage.
While the FICO score is widely used, it is not the only credit scoring model available. Some lenders may use alternative models, such as VantageScore, which was developed by the three major credit bureaus in response to the dominance of the FICO score. Like the FICO score, VantageScore uses a range of 300 to 850, with higher scores indicating better creditworthiness. However, VantageScore places more emphasis on recent credit activity and trends than on the length of credit history.
Improving Your FICO Score
If you are looking to improve your FICO score, there are several steps you can take. The most important step is to make all of your payments on time. Late payments can have a significant negative impact on your score, so it’s important to prioritize paying your bills on time. Another important step is to reduce your credit utilization ratio, which is the percentage of available credit that you are using.
A high credit utilization ratio can signal to lenders that you are overextended and may be at a higher risk of default. To improve your credit utilization ratio, you can pay down your balances or request a higher credit limit.
In addition to these steps, you should also review your credit report regularly to make sure that it is accurate. If you notice any errors, you should dispute them with the credit bureau and have them corrected. Finally, be cautious when applying for new credit. Too many credit inquiries can lower your score and signal lenders that you may be at a higher risk of default.
FICO Scores and Credit Reporting Agencies
It’s important to understand that the FICO score is based on data provided by the three major credit reporting agencies: Equifax, Experian, and TransUnion. These agencies collect and maintain information about your credit history, including your payment history, credit utilization, length of credit history, and new credit inquiries. They also collect information about public records, such as bankruptcies, foreclosures, and tax liens.
Credit reporting agencies use this information to generate a credit report, which is a summary of your credit history. Lenders use credit reports to evaluate your creditworthiness and decide whether or not to approve your application for credit. Credit reports also play a role in determining the interest rate and credit limit that you will receive.
It’s worth noting that each of the three credit reporting agencies may have slightly different information on file, which can lead to variations in your FICO score. That’s why it’s important to review your credit reports from all three agencies to make sure that they are accurate and up-to-date.
FICO Score Ranges
The FICO score ranges from 300 to 850, with higher scores indicating better creditworthiness. Here’s a breakdown of the FICO score ranges and what they mean:
- 300-579: Very Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very Good
- 800-850: Exceptional
It’s important to note that different lenders may have different cutoffs for what they consider to be a “good” credit score. For example, one lender may require a minimum score of 650, while another may require a minimum score of 700.
FICO Score Factors
The FICO score is calculated based on five factors, each of which has a different weight in the calculation:
1. Payment History (35%):
This factor looks at whether you have made payments on time and how often you have been late. Late payments can have a significant negative impact on your score, so it’s important to make all of your payments on time.
2. Credit Utilization (30%):
This factor looks at how much of your available credit you are using. A high credit utilization ratio can signal to lenders that you are overextended and may be at a higher risk of default. To improve your credit utilization ratio, you can pay down your balances or request a higher credit limit.
3. Length of Credit History (15%):
This factor looks at how long you have had credit accounts open. Generally, the longer your credit history, the better your score.
4. New Credit (10%):
This factor looks at how many new credit accounts you have opened recently. Too many new accounts can lower your score and signal lenders that you may be at a higher risk of default.
5. Credit Mix (10%):
This factor looks at the types of credit accounts you have, such as credit cards, mortgages, and car loans. Having a mix of different types of credit can help improve your score.
It’s important to note that these percentages are approximate and can vary depending on individual circumstances. Additionally, the FICO score is not the only factor that lenders consider when making credit decisions. Lenders may also consider factors such as your income, employment history, and debt-to-income ratio.
In conclusion, the FICO score has become an essential tool for lenders in evaluating the creditworthiness of individuals. By understanding the factors that go into calculating the FICO score and taking steps to improve their credit, individuals can increase their chances of getting approved for credit and receiving favorable terms.
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