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How Does Your FICO Credit Score Work

If you thought that graduating meant the end of people grading and assigning you a number, think again. In the real world, it’s not your GPA that matters, but your FICO score. It’s a three digit number that is supposed to give creditors an idea of how credit worthy you are. Technically, it’s a measure of how likely you are to default on your debts.

It’s obvious why credit card companies, mortgage lenders, banks, and the like are interested in your credit score, but did you know that your employer, your landlord, your cell phone company, and your cable company are interested in it too? Anyone who may lend you something, like your cell phone company giving you cell phone minutes before you pay for them, is interested in how likely you are to make good on your financial promises. Your credit score has taken a life of its own, it’s about time you understood the beast.

This post is part of Bargaineering’s 2010 New Graduate Guide [3] series where I’ll share my insights and offer my financial guidance to the graduate class of 2010. This post is part of day 2, the financial basics.

What’s In Your Score

Fair Isaac isn’t in the business of revealing how they calculate that magical three digit number, that would be like giving away the recipe for Classic Coca-Cola, but they do tell you what’s inside. It’s a mixture of your payment history, your amounts owed, the length of your credit history, your new credit, and the types of credit used. You can read more about the breakdown of each category at myFICO [4], Fair Isaac’s retail site, but it’s mostly common sense. Spend within your means, pay back your debts, and show you are a responsible borrower.

Check Your Reports

The Fair Credit Reporting Act [5] (and an amendment, the Fair and Accurate Credit Transaction Act) gives you the right to review your credit report every twelve months for free. The government even set up AnnualCreditReport.com [6] to help facilitate the process of getting your report. There are three major credit bureaus (Experian, Equifax, TransUnion) and you are entitled to one report from each, every twelve months.

Review your reports at least once a year and repair any errors, no matter how insignificant they may seem. Dispute items on your credit report immediately because the resolution process can take several months. If you intend to get a loan, you want that report as accurate as possible, as soon as possible.

Check Your Score

The free credit reports will not give you access to your credit score. To get that you have a few options, which I’ve listed on my page detailing how to get a free FICO credit score [7]. In general, you will need to sign up for a free credit monitoring trial, get your credit score, and then cancel the trial before it ends. This is a little bit of hassle but it does get you a free look at your score.

I don’t think that knowing your credit score is important. Your time is better spent ensuring that your report is accurate, rather than what the number is. If you really want to know, I find that using Credit Karma [8] to get your TransUnion credit score is adequate. It’s not a FICO score but it’s 100% free (it’s ad supported), you can’t really beat that.

It’s important to understand how your FICO credit score works and how to keep it in good shape, even if you don’t plan on borrowing any money. It’s not a perfect system, far from it, but it’s the one we have to operate in and it’s much easier to maintain a good score, than repair it.

(Photo: fosforix [9])