What is Fico Score and How Does it Work?

What is Fico Score and How Does it Work?

October 8, 2021

The Fair Isaac Corporation developed a credit score known as a FICO Score (FICO). Lenders analyze credit risk and decide whether to provide credit based on borrowers' FICO Scores and other information on their credit reports. To evaluate your borrowing ability (creditworthiness), FICO considers financial data from the following categories:

  • Payment history
  • The current amount of indebtedness
  • Duration of credit history
  • Credit mix
  • New credit accounts 

FICO Credit Scores Explained!

FICO is a large analytics firm mostly recognized for developing the credit scoring system that financial institutions use to determine the borrowers' creditworthiness. The FICO Score range varies between 300 and 850. Generally, the credit range of 670-739 reflects good credit; thus, most lenders would consider it favorable. On the other hand, borrowers with scores in the 580 to 669 range will likely face troubles when taking out loans at competitive rates. Indeed, most traditional lenders use your FICO score when determining your creditworthiness, but they also consider other factors such as income or length of employment. 

Why is the FICO Score Important? 

FICO scores are the most popular scoring system in the US, utilized in more than 90% of credit decisions. Although borrowers struggle to justify mistakes on credit reports, having a low FICO score is the primary factor for many lenders, particularly in the mortgage business, where strict minimums come into practice. A good FICO Score is based on having a good credit mix as well as solid payment history. Borrowers should also be careful to maintain balance on credit cards below the agreed credit limits. Maxed-out credit cards, late payments, and hasty credit applications all harm FICO ratings.

How Is FICO Score Calculated?

FICO calculates credit ratings by weighing each category differently for each borrower. This information is split up into five categories: payment history (35%), amounts owed (30%), length of credit history (15%), credit mix (10%), and new credit (10%). 

Payment History

Payment history indicates how you've paid your bills over the course of your credit history. This payback information is the key reason why payment history accounts for 35% of your FICO Score. According to research, your payment history is the best indicator of paying all obligations as promised. And, as you might expect, a lender's top priority is your track record of repaying debts. 

Amounts Owed

Indeed, accounts owned show the entire debt amounts held by the borrower. Having a lot of debt does not always imply having a bad credit score, as FICO prioritizes evaluating the debt-to-credit ratio. For example, a person owning $5.000 debt with a maxed-out credit card may have a worse credit score than the one who owes $50,000 but is far from exceeding his credit limit. 

Length of Credit History

As a general rule, the longer a person has had credit, the higher his score. Nevertheless, this is not dogma as if you succeed in other categories, you may still have a good FICO Score. FICO ratings include the age of the oldest and newest accounts and the overall average. 

Credit Mix 

The credit mix mainly applies to the types of accounts that comprise your credit report. Credit mix makes up 10% of your FICO Score. Credit cards, student loans, mortgages, sometimes even payday loans online are examples of different forms of credit that may be included in your credit mix. 

New Credit

Accounts that have recently been opened are referred to as new credit. If a borrower opens multiple accounts in a short period, it shows risk and reduces their credit score. Inquiries about new credit remain on a credit record for two years after you apply for it. However, FICO Scores only take into account inquiries from the previous 12 months.