An individual’s credit score will determine the interest rates he or she receives when applying for a credit card or a loan. An excellent credit score can save the consumer over $40,000 in interest over the life of a 30-year mortgage loan. However, the credit score impacts more than the individual’s ability to get approved for a loan, get a credit card or save money on interest. Employers may check a candidate’s credit history when performing the background check. Auto insurance companies now use the credit score to determine the rates that a driver will pay for an insurance policy. Landlords will perform a credit check to determine the credit scores for potential tenants. Fact is, having a good credit score will save the borrower money with lower interest rates. However, a person with good credit will also receive more competitive insurance rates, may be chosen as a tenant for a rental property and may possibly be chosen over another candidate for a job.
The Credit Score Defined
The credit score is a score that evaluates a person’s credit history with a single number. The most commonly used credit score is the FICO score. Though other credit scores, such as the Vantage score, are available for lenders to use to determine creditworthiness, 90% of the largest lenders prefer the FICO score. FICO scores range from 300 to 850 and this score provides a potential lender or someone inquiring about an applicant an instant evaluation with regards to his or her creditworthiness.The FICO score was developed and trademarked by a the Fair Isaacs Corporation. “FICO” is an acronym for the company’s name. The formula for the FICO score was developed in the 1950s by Fair Isaacs, and the exact calculates used to generate the score are a trade secret owned by the company. However, the factors that are utilized to generate the FICO score are available to the public. Financial experts have also estimated the weighing of each factor that determines the score. We are able to review expert consensus with regards to the percentages assigned to each factor to determine the FICO score.
Factors that determine an individual’s FICO score include:
- Total length of credit history
- Payment history
- Newly obtained credit
- Recent inquiries on credit reports
- Total amount of debt
- Amount of unused credit available
Though only the Fair Isaacs Corporation knows the exact weighting of each factor, it is common knowledge that some factors are more important than others. The most important factors are believed to be the total length of credit history, payment history and the ratio of available credit to debt. Financial experts recommend that people use only 1/2 of the credit that is available to them.
WealthPilgrim.com estimates the weight of FICO score factors by the percentage of the score determined by each factor. Though these percentages are simply an educated guess, most financial experts are in agreement that they are descriptive and, for the most part, accurate.
Payment history – 35%
Ratio of Debt to Available Credit – 30%
Length of Credit History – 15%
New Credit Applications – 10%
Types of Credit – 10%
Other factors beyond the FICO score may be assessed for loans, mortgages and other credit opportunities. Factors such as length at current job and time in current home are also considered. Banks and mortgage companies may use FICO scores and other factors in different ways. This is why a potential borrower may have a high FICO score but still be denied for a mortgage from a lender. The same individual could then apply and be approved for a mortgage with the same terms by another bank.
The Distribution of FICO Scores
Fair Isaacs reports that the median credit score for people in the U.S. is 723. The mean, or average, credit score in the U.S. is 687. The distribution of FICO scores has remained relatively steady, even through the economic downturn between 2008 and 2011. One might expect that more people would have ended up with poor or bad credit due to layoffs and massive foreclosures. However,according to FICO.com, the data does not support this assumption.
Very few people have an “excellent” credit rating. A FICO score over 750 is considered to be in the “excellent” range. Though lenders may determine their own standards, generally a FICO score between 650 and 749 is consider a “good” credit rating. Scores between 550 and 649 are generally considered to be a “fair” rating and scores between 450 and 549 are generally considered to be “poor.” A “bad” credit score is a FICO score under 449.
According to FICO.com, 18.1 percent of the population had FICO scores over 800. On the other end of the spectrum, about 15 percent of the population had FICO scores under 550. The majority of FICO scores for individuals in the U.S. fall in the range of 600 to the upper 700s.
Other Factors that Impact the FICO Score
An individual’s FICO score may be affected by factors that are out of their direct control. For example, the credit reporting agencies occasionally list errors on credit reports. Lenders sometimes mis-report credit data and individuals may fall victim to identity theft. People can minimize the chances of any of these unfortunate occurrences happening by closely monitoring their credit report from all three credit bureaus.
The Three Major Credit Bureaus
Three credit reporting agencies maintain and aggregate all credit records and personal information for all Americans with reported credit histories. Equifax, Experian and TransUnion are the three credit bureaus in the U.S. All three credit bureaus are for-profit businesses, and are not under the oversight of the Federal government, as many might assume. Credit bureaus turn a profit by selling subscriptions to lenders and by selling credit reports and FICO scores to consumers. Individuals may obtain one free credit report per year from each credit bureau. Additional copies are available for $11 or less.
All three credit bureaus offer a free credit report each year for all consumers. Free reports from each of the three agencies may be obtained by completing one form at AnnualCreditReport.com. Consumers may also request their credit reports by calling 1-877-322-8228. Reports requested by phone are mailed to the recipient within 15 days. Credit reports may also be requested via U.S. Mail. Download the PDF form from AnnualCreditReport.com and mail the completed form to the provided address.
All consumers should obtain their credit report at least once per year from all three credit reporting agencies. Because lenders may subscribe to one, two or all of the credit bureaus, each agency may have different information about each consumer’s credit history. It is important to monitor the reports from all three credit bureaus. Errors on a credit report may be challenged by the consumer. All three credit reporting agencies provide a web-based dispute form for consumers to challenge and correct errors on their credit report.
For more information about credit bureaus and consumer rights, visit the Federal Trade Commission website at www.consumer.ftc.gov.