What is a FICO score and what do you need to know?

Remember in grade school where there was a direct correlation between hard work and earned grades? The way it likely worked is when you tried hard and studied well, you got a good grade. When you didn’t study, you earned a worse grade, right? Unlike grade school, your FICO score has some additional ripples that makes it harder to decipher. Fortunately, we’ve got a roadmap below that should put you on your way to a higher score and increased opportunity for you going forward.

A FICO score is a number between 300 and 850 that is used to give lenders a guide to determine a person’s ability and likelihood to pay back loans. The higher the score, the more likely you are to appropriately use credit, and therefore likely to receive favorable terms when trying to get a new form of credit. The information used to determine a FICO score is based on data points and other information gathered on a person by the three credit bureaus: Equifax, Experian, and TransUnion. Many Companies used these scores to determine your credit worthiness. Most mid-high 600’s as a good score, and mid-700’s as very good. The good news is that your credit score fluctuates every month, so no matter what your score is, you can put in the work to up your score.

Your FICO credit score is broken out into five individually weighted aspects. We’ll break them down in detail below, but here is how they weight:

• Credit history – 35%

• Credit utilization ratio – 30%

• Age of credit history – 15%

• Credit mix – 10%

• New credit – 10%

Credit History

Your payment history accounts for 35 percent of the total credit score and the biggest factor impacting your credit score calculations. Credit bureaus monitor nearly all credit facilities, including credit cards, personal loans and mortgages. Previous behavior is used to predict future behavior. Making on time payments on all of your credit obligations is a great way to ensure your credit history remains clear. Payment issues, bankruptcies, or collections can lead to derogatory marks on your credit report that can impact your score for up to seven years. One of the best ways for borrowers to improve their credit score is by making consistent, timely payments. 

Here are some tips to ensure your credit history stays as clean as possible:

• Have a plan to pay off your cards.

• Set up automatic payments on credit cards to ensure payments are not missed.

• Set calendar reminders for when payments are due to ensure you don’t overdraw your bank account. 

Credit Utilization Ratio

The next biggest FICO score factor is your credit utilization ratio. This ratio how much you owe on credit divided by your total credit limits. For example, if you owe $1,000 on your $10,000 credit limit, your ratio is 10%. The lower your ratio, the more it is interpreted by credit services that you’re spending within your means and properly managing credit. While your initial credit limit with an issuer can be lower as you establish relationships with them, your available credit line can steadily grow over time as you build the relationship. While an individual issuer may consider your utilization ratio you have with them specifically, your overall FICO credit score is the total of all credit facilities on your credit score. Therefore, while maybe Bank of America may consider if you’ve maxed out your credit card with them while trying to open up a new Bank of America credit card, your FICO score will include the unused credit from any other credit cards, lines of credit or other credit facilities you have to your name. A typical rule of thumb is you want to keep your utilization below 30%. 

Here are some tips to keep in mind as you focus on your credit utilization ratio:

• Keep your ratio under 30%.

• Pay off credit card mid-cycle to lower borrowed funds.

• Request a credit limit from your credit card issuer or open up a new credit card (if appropriate). 

Age of Credit History

As we discussed earlier, while the behavior of your credit history is the most important factor to your FICO score, credit bureaus also track the average age of your credit history. After all, you should get more benefit of the doubt for making timely payments over a 10 year span than a 10 month span, right? Age of credit history is only 15% of your total FICO makeup, but it’s important to think about how not only new credit lines but old credit lines will impact your score. It should be obvious that opening up a new credit card or taking a new loan will lower your average age of credit. However, it’s important to think about your older lines of credit and trying to keep them active, if possible. Many credit card issuers will close dormant accounts after a period of inactivity (typically a couple of years). If you have an old credit card that you don’t use anymore, it may be worth making a small purchase on it annually to keep active. This is an easy way to keep your credit history higher. Additionally, if you’re ever considering cancelling a credit card that has an annual fee, it’s worth asking the credit card issuer if there is a no annual fee version of the card you can downgrade to, which will keep the credit history on your score. 

Here are some tips to keep in mind as you focus on your average age of credit history:

• Keep oldest active accounts in spending rotation (at least annually) to avoid inadvertent shutdown.

• Be conscious of new accounts open and ensure the benefits are worth the impact on your average age of credit.

• Ensure avenues are researched before closing active lines of credit.

Credit Mix

Your credit mix is the combination of different types of instruments that make up your credit portfolio. This mix includes credit cards, student loans, personal loans, auto loans, and mortgages. Bureaus favor a healthy mix of various types of credit to ensure the consumer is well rounded and can juggle multiple debt instruments simultaneously. This mix only makes up 10% of your total FICO score, so I wouldn’t go out of your way to open a new line of credit just to satisfy this aspect. 

Here are some things to consider when considering your credit mix:

• A credit mix only makes up 10% of your credit score.

• It’s better to have the mix (or lack of mix) that is right for you.

• Companies like to see your ability to manage multiple types of credit simultaneously.  

New Credit

The last and tied for least important factor in your FICO score is the impact that new credit has. Each time you open a new line of credit, a tracked inquiry is made on your credit (typically referred to as a “hard pull”). This is tracked to see how often you’re looking for new lines of credit. Companies tend to view someone often looking for new lines of credit as risky as they may be either desperate for credit or churning through credit lines.  While each company will view their inquiries differently, here are some things to remember when considering new credit.

Here are some things to consider when considering new credit:

• Inquiries stay on your credit score for two years, while FICO only uses one year in your score calculation.

• Ensure when applying for new credit that what you’re gaining is worth the inquiry.

• Research the requirements set by the Company for credit you’re applying for to ensure you meet the requirements to be approved (don’t waste an inquiry). 

When considering the above five factors, you should be able to more clearly guide yourself through the ins and outs of your credit score. While this can be used as a good rubric, it’s important to determine what are your needs and wants, and when is the time to open or close credit accounts. If there are any questions on the above or other credit score related questions, let us know!