You may have heard that your credit score is important, but what is a FICO score? FICO is short for Fair Isaac and Co. The Fair Isaac Company developed custom software back in the 1980s that helped other companies determine a credit risk based on a number derived from a person’s credit history. This number soon became a standard that was adopted by the three main credit bureaus: Experian, TransUnion, and Equifax. The FICO score ranges between 300 and 850.
Credit Score vs. Credit Report
A credit score and a credit report are two different things, although the credit score ultimately depends on your credit report. Your credit report is simply a detailed account of your credit history. The report will contain information such as:
- Current credit accounts
- Payment history
- Credit inquiries
- Credit utilization
Your credit report itself does not have a FICO number. It is simply a report of your current and past credit history. Most credit history will only go back seven years, although a bankruptcy will stay on your report for ten years. You’re entitled to a free credit report each year and it’s always a good idea to check it annually to make sure it’s correct. Here’s how to get your free credit report.
A FICO credit score is based off of your credit history, but it’s not actually a part of your credit report. Instead, the three major credit bureaus will calculate your FICO based on your credit history they have on file. This means you can have up to three different FICO scores at one time. Your FICO score does not come with your credit report and it isn’t something you’re entitled to annually. You may have to pay a fee to actually receive your score.
What Makes Up a Credit Score
A credit score takes into account a lot of different information from your credit report, but it’s not all treated equally. Some aspects of your credit history are more important than others and will weigh more heavily on your overall score. Your FICO score is essentially made up of the following:
- Payment History – 35%
- Total Amounts Owed – 30%
- Length of Credit History – 15%
- New Credit – 10%
- Type of Credit in Use – 10%
As you can see, the bulk of your credit score comes from your payment history and how much debt you actually have. Those two items account for 65% of your score. So, if you’re really looking to improve your credit score, these are the areas you’ll want to tackle first.
Why Your FICO Credit Score is Important
We’ve determined what makes up a credit score, but why is it so important? Your credit score will follow you for your entire life and if you are ever trying to borrow money, the lender is going to look at your credit score to determine whether or not to lend money to you. Need to buy a car? They will check your credit score. Looking for a mortgage? You can bet they are checking your credit score. In fact, even some employers are checking credit scores when hiring to possibly determine who would make a good employee.
Not only does your credit score determine whether or not you’ll receive financing, it also determines how much it will cost you to borrow that money. People with higher credit scores are deemed to be less of a risk and therefore will typically receive the lowest interest rates. Those with lower scores are viewed as more of a risk so the bank will offset that risk by lending you money at a higher interest rate. And when you’re talking about larger loans such as buying a vehicle or a home, just an extra interest rate point could add up to thousands, and even tens of thousands of dollars wasted on interest.
Improving Your Credit Score
What happens if you have made some mistakes in the past and now your credit score is low? Don’t worry. The good news is that your credit score is constantly updating, so every month as you begin to make improvements to your credit history, your score will be sure to follow. But keep in mind that items on your report will stay there for seven years, so it will take some time for serious negative marks to eventually disappear completely.
Thankfully, there are a number of things you can do to improve your credit score. Start with the basics and make sure you’re making all of your payments on time. Remember, payment history is the single greatest factor in your credit score. If you make payments over time, you’ll slowly start to raise that score. Second, reduce your total amount of debt. The second largest impact on your score is how much debt you have, so if you can put a dent in your overall debt you’ll also begin to make some serious headway. But don’t stop there. Here are more ways you can improve your credit score.