Understanding FICO Credit Scores

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For the first twenty years of your life, the most important measure of your future were your grades in school. Scored well, you got into better schools and tougher classes. Scored poorly and you didn’t. Just about the time I thought grades stopped mattering, I learned about my FICO credit score.

This little three digit number has caused so much consternation in its lifetime you’d think it was invented hundreds of years ago. Would it to surprise you to learn that the FICO score, for all its flaws, is actually an improvement on its predecessor? Before the Fair Credit Reporting Act in 1971 (full text of the FCRA), credit reporting agencies did whatever they wanted.

They collected whatever information they could find and sold it to whomever was willing to pay. The idea of a “credit score” didn’t emerge until the 1980s when Fair Isaac Corporation (FICO) put the data through a magical black box equation and spit out a three digit FICO score.

Pique your interest? Enough of the history lesson, let’s learn about FICO scores, how they are calculated (as best we know), and get on with this Foundation Series post!

One FICO Credit Score

Fair Isaac Corporation (hence the acronym FICO) created the FICO credit score. The three digit number ranges from 300 to 850, with a higher score being better. The score is used, with other factors, for two decisions:

  1. Whether or not to extend you credit,
  2. The interest rate to charge you for that credit.

The idea behind the credit score is that it gives an indication of your creditworthiness. A person with a higher credit score is more likely to repay their debt than a person with a lower credit score. Lenders use this information in lending decisions because they want to know about a borrower before they lend them money! Lenders also accept that a certain percentage of their loans will default but they use credit scores to ensure that they still run a profitable operation.

Other credit scores: There are a few other credit scores out there but none have the popularity and history of the FICO score. The three major credit bureaus tried to band together to create VantageScore, a FICO score competitor, but each continues to offer a FICO score because of its popularity. Since many lenders and creditors use FICO scores, so should you.

Three Major Bureaus

There are three credit reporting agencies: Equifax, TransUnion, Experian. Equifax is the oldest of the three, having been founded in 1899, and is based out of Atlanta, GA. Experian is an international company with corporate HQ in Ireland and an operational HQ in Costa Mesa, CA. TransUnion is the third largest and began as a subsidiary of Union Tank Car Company in 1968, but is now an independent company located in Pennsylvania.

Wonder why your scores differ across the three? Slightly different formulas but mostly because of inaccurate information. Unfortunately the credit reporting system in the United States is voluntary. Companies are not required by law to report your credit activity and so the reporting can be uneven. For example, most credit card companies won’t report late payment unless it’s over 30 days or 60 days late. They don’t report it because they don’t want the added expense of reporting it, especially if they can avoid it and build up goodwill with the customer.

What It Considers

There are five major categories included in your FICO score:

  1. 35% — punctuality of payment in the past (only includes payments later than 30 days past due)
  2. 30% — the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
  3. 15% — length of credit history
  4. 10% — types of credit used (installment, revolving, consumer finance)
  5. 10% — recent search for credit and/or amount of credit obtained recently

As you can see, the categories are broad and the percentages are merely guidelines. This is done by design because Fair Isaac doesn’t want you to know the equation because you’ll try to game it. Fair enough! Fortunately, it does include enough information to give you an idea of what you’ll need to do if you want to improve your credit score.

What It Ignores

Everything else. It doesn’t take into account you (so no race, religion, age, gender, and marital status as required by the Federal Reserve Board’s Regulation B), your jobs (salary, title, employer, employment history), current rates (what you’re paying on a mortgage or car note or student loans), and extracurricular credit activities (such as credit counseling, because it’s not reported).

Five Facts to Know

  1. Every year, you are entitled to a copy of your credit report through the government’s website. You will want to pull this once a year to check for inaccuracies or errors. Do not go anywhere else to get your free report. You will not get your credit score.
  2. If you spot an error, dispute it as soon as possible. The dispute resolution process can take a long time, with a lot of information verification, so you’ll want to start it early, even if you don’t think it’ll matter.
  3. There are no quick ways to increase your credit score. Credit score repair companies will promise you anything, but there’s not much you can do in the short term to increase your score. Those companies usually try to either trick the bureaus into removing negative items or trick you into paying them for nothing.
  4. Credit scores can sometimes be used in untraditional ways. Some employers are using credit scores to make hiring decisions!
  5. If you want your score, you have two options. The first is to use a credit score estimator, which seem to be reasonably accurate. The second option is to sign up for the myFICO ScoreWatch 30-day trial, getting your score, and then canceling the subscription.

This is by no means an exhaustive look at credit scores but hopefully I’ve armed you with a good enough understanding and a large enough vocabulary that you can do more research. If there’s something I missed that you think I should include, please let me know!

(Photo: Andres Rueda)

{ 28 comments, please add your thoughts now! }

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28 Responses to “Understanding FICO Credit Scores”

  1. One thing to add is that it totally ignores your current assets.

    For example, if I were to give you 10 million dollars today, your credit score would not change one point (unless you used it to get more debt or pay down existing debt).

    • Jim says:

      That’s right, but I think the other indicators make up for that short-coming because if you have $10M and are not a responsible borrower, then you’re still not a responsible borrower.

  2. Kyle says:

    The problem is that so many companies rely solely on the credit score of someone to determine their ability to repay a loan, in many cases this could be a poor indicator, such as the example Baker Provided

    • Wizard Prang says:

      Agreed. Dave Ramsey refers to FICO as an “I-Love-Debt” score. Those old-skool folks who save and pay cash (what a quaint idea) end up having no Credit Score at all, due to insufficient data.

      One result is that lenders have mostly become “FICO monkeys”, just running the score without doing their due diligence about the borrower’s ability to repay.

      I believe that this should be necessary for the lender to qualify for protection under the (horrible) Bankruptcy Protection Law that is currently on the books.

      • Andrew says:

        It’s possible to build up an excellent FICO score and make money over time without accumulating debt. Just put a purchase on a reward credit card and pay for it when the bill arrives. Repeat.

        • wizardprang says:


          True, but missing my point. There is a difference between “accumulating debt” and getting into debt.

          Bottom line: You cannot get a FICO score without getting into debt, i.e., borrowing.

          Personally I have found most of the rewards/loyalty schemes to be not worth the trouble; and when they are, the lender invariably changes the rules until they aren’t. If you can profit from it, good for you. I have yet to find one where the reward was worth the risk.

          • jim says:

            Credit card rewards works just fine if you get cash back card. Amex, Discover & Citibank all have cards that give back cash with no special strings attached. Theres no risk and you get an easy 1-2% back on everything you buy.

          • Andrew says:

            This is not correct. You could make a payment and THEN charge something. No debt, not a penny, not for a minute, and you build up your credit score over time. However, anyone with that extreme an aversion to debt may want to seek psychological help. What possible harm can result from my purchasing a tank of gas with a credit card (getting a whopping 5% rebate by doing so, BTW) tonight and then pay for it on Friday when I get my paycheck? I have the money today, both in my wallet and again in my checking account, but it’s my habit to pay off all my bills every other Friday when I get paid. So while I’m “in debt” in the purest sense, that’s a mere technicality.

          • wizardprang says:

            “…with no special strings attached. Theres no risk and you get an easy 1-2% back on everything you buy…”

            Risk? What know you of risk

            Sorry, couldn’t resist 🙂

            What if your payment does not get through on time?
            What if your employer goes belly-up and “forgets” to pay you (can we say “Enron”?) ?

            Perhaps 1-2% is enough incentive for you, but me it is not worth the work for the $10-$20/month this would net me. I prefer to deal in cash or use my Debit card and have one less bill to pay at the end of the month. I guess that makes me weird.

          • wizardprang says:

            Sorry, that was supposed to say

            [Yoda] Risk? What know you of risk? [/Yoda]

            but the page removed the angle-brackets

          • dilbert69 says:

            The risk of late payment can be eliminated if you pay online and pay as soon as you make the charge, even before you get the statement. The risk of your employer forgetting to pay you is irrelevant since if that happens you won’t be able to meet your expenses regardless of how you pay for them, unless you’ve accumulated savings, which I’m sure everyone reading this blog has.

          • Jim says:

            Well technically that wouldn’t improve your score because the card issuer wouldn’t report a balance. 🙁

          • wizardprang says:

            “You could make a payment and THEN charge something. No debt, not a penny, not for a minute, and you build up your credit score over time.”

            Good point, and a good approach… But how many people do that?

            “However, anyone with that extreme an aversion to debt may want to seek psychological help.”

            Tell that to Dave Ramsey.

            “What possible harm can result from my purchasing a tank of gas with a credit card..?”

            No harm… unless you lose your job, or you don’t get paid and you have no savings… or your payment is late and they hit you for a $35 fee. Or you get hit by a truck and end up in a coma and…

            Oh sorry, where was I? And who are you? 🙂

            I used to have a 5% Discover gas card. Then they limited the reward to $60/year, so I used it for the first 3-4 months of the year, got the reward and stopped using it. Then they got wise to that and further limited the reward to $5/month, payable in $20 chunks. At that point I decided that it wasn’t worth $5/month to me and I said “bye-bye”

            “I have the money today, both in my wallet and again in my checking account… while I’m “in debt” in the purest sense, that’s a mere technicality.”

            Nothing wrong with that… but if you already have the money you don’t need to be using a CC! So you are borrowing (yes, it is a technicality, but it is still “borrowing”) money that you don’t need to borrow in order to raise up your FICO score. Lunatics, the Asylum takeover is now complete 🙂

            It just strikes me as odd that the only people who can really benefit from a CC are those who don’t need one. I do not consider Credit Cards to be inherently evil (though a good friend of mine does), but they seem to be marketed directly at people who can’t afford them or don’t know how to use them properly.

            I wonder how much of this “playing-games-with-money” mentality landed us in the sorry mess in which we find ourselves now…

          • creditnewb says:

            “technically that wouldn’t improve your score because the card issuer wouldn’t report a balance”

            Jim, I know this article is a little old. I believe this was in reference to paying off your balance as soon as you charge it.

            Have the rules changed? I am under the impression that you do not need to carry a balance over for your credit to improve. Is there a source we can use to verify one way or the other?

          • Jim says:

            You don’t need to carry a balance but you would need it to be report to the bureaus. So you make the charge, the statement period closes, the company issues you a statement, then you you pay it off. You don’t pay interest because you pay off the balance by the time it’s due. The statement balance is reported to the bureau. So you pay no interest, you get credit for responsibility, and you don’t “carry” a balance.

  3. Andrew says:

    FICO score is a better indicator of willingness to pay than ability to pay, especially at the margins.

  4. Khyron says:

    Also keep in mind this VERY VERY VERY little known fact…

    The lenders, also known as credit issuers, such as banks (HSBC, BofA, Citi, , J.P. Morgan, etc.), oil companies (Shell, Exxon, etc.) and any other lenders you can think of, have to PAY the credit bureaus to report data to them. Yes, the issuers pay the bureaus for the privilege of having the bureaus collect the data. On top of that, the issuers pay HIGHER fees to report bad data (delinquencies, charge-offs, etc.) So this plays into why certain issuers may only report to 1 or 2 bureaus, and why they only report certain data at certain times. It hits them economically to report bad information about you. The beneficiaries of that economic hit are the bureaus, because they actually get paid on the basis of the information reported to them.

    It also explains why they are dis-inclined to update your information — if the issuer is reporting good data about you (you brought the account current, etc.), that reduces the fees the bureaus charge the issuers, thus reducing the revenue that the bureau generates. They want negative information to be reported as part of their business model!

  5. Ryan says:

    The truth is that most of the richest people in the world do not advise getting into debt. That’s really not how you win with money, regardless of what broke financial people might say. And a FICO score is utterly useless if you’re planning on buying things you can actually afford, rather than borrowing to get them. Also, considering that people who use credit spend 12-18% more than those who use cash (even if they pay it off every month), I wouldn’t say the 2-3% reward is worth it! You’re still 9-15% in the hole!

    • wizardprang says:

      Ryan, you MUST be a fan of Dave Ramsey; you sound just like him. 🙂

      My main problems with the FICO are a) how horribly mis-used it has become (mainly because it’s cheap and easy), and b) how the absence of a FICO score is assumed to be bad news… when I emigrated here from England in 1994, I had a good job here, thousands in the bank, and a CC with a $50k limit (drawn on a British Bank) in my pocket, but without the almighty FICO nobody would touch me with a barge pole. Nowadays the lending industry has turned into FICO monkeys who run the score instead of actually checking if you are earning money.

      The only debt that most of us _need_ is a Mortgage. And I would run from any Mortgage Lender who bases their entire financial investigation on a FICO score…

    • dilbert69 says:

      Just because _people_ who use credit spend more than _people_ who don’t doesn’t mean that _you_ would spend more if _you_ used credit. Also, a FICO score is very useful if you are planning to buy a house (which almost no one can afford to pay cash for) or get a non-prepaid cell phone.

      • wizardprang says:

        1) You’re right. There are exceptions. But that does not mean that the rule is wrong. McDonald’s did not put in ATM swipes in every store in the country because they were feeling generous. They put them in because it is extremely profitable.

        2) Not a problem if your mortgage lender is a _real_ lender and not just another FICO monkey. Show them 20% down and a solid payment record and watch their reaction.

        3) It’s easy to get a phone without a FICO score – just give them a deposit, which you get back after a year. An annoyance, true, but it can be done.

        I am not saying that the FICO is evil, just that is it not as important as some of us make it out to be – just like Wall Street.

        For those of us who stay out of debt, a FICO score can, at least in theory, be completely unnecessary. Mine is in the mid-700s, but I have never really worried about it. The only time it will ever matter is if I intend to borrow money – and I don’t intend to ever do that again (except for a MTG). Therefore it is not important to me. Your mileage may vary.

        • dilbert69 says:

          No one is going to underwrite a mortgage without taking into account your FICO score, regardless of your down payment and payment record. If your FICO score is low, you’ll pay more even if you’re approved. My FICO score is over 800, and I recently got a 30-year fixed-rate mortgage (refinance of existing mortgage) of $500K (80% LTV) for 4.875% and no points, and about $3K of closing costs.

  6. dilbert69 says:

    This URL says that manual underwriting doesn’t exist. It’s about a year old.

    Also, I have an 800+ credit score and carry no debt. You can build up a credit score by using credit, not by carrying debt. I think Dave Ramsey is just wrong.

  7. Dennis says:

    One thing is really obvious about credit scores (FICO), they were ignored for years on home loans, or how else did ten’s of millons Americans end up with houses they could’nt afford?

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