What is my FICO Score?
Your FICO Score is a number, in the range of 300-850, that represents how risky it would be for someone to loan you money. It is calculated based on data from a credit report about you.
Why should I care?
The way you use credit now will dramatically influence the amount it will cost you to borrow money later. The images below are from MyFICO.com, which is run by the company that calculates your FICO Score.
If you had a FICO Score of 720 and you bought a $25,000 car on a 3 year loan, you would pay $27,648. If you had a score of 659, you would pay $29,916 for the exact same car. If you had a score of 589 (and you managed to get a car loan), you would pay $31,752.
Getting and keeping a high credit score would save you $4,104 on a typical car loan.
A high credit score is even more important when you buy a house with a mortgage. If your FICO Score was 760, a $300,000 house with a 30 year mortgage would cost you $624,960. Buying the same house with a score of 659 would cost you $717,840. If you managed to get a mortgage with a score of 579, that house would cost you $972,720.
A great credit score would save you $347,760 on a typical mortgage.
How is my FICO Score calculated?
Your FICO Score is based on data from one of your credit reports. The company that calculates your FICO Score refuses to share the exact formula they use. What they do share are the general categories of data about you that influence your score and how much each category maters.
Understanding a little about each category can help you make educated guesses about how what you is likely to affect your score.
Payment history is easy to understand. A long history of on time payments will help your score. A short payment history won’t help. A late payment will dramatically hurt your score. Many late payments will devastate your score.
Amounts owed is a little more complex. The total amount of money you owe is important, but there’s a more complex part. The ratio of your used to total revolving credit maters a lot. A high ratio will hurt your score.
Revolving credit means that you can borrow some money, pay some money back, then borrow some more money. Credit cards are the most common type of revolving credit. When you pay part of your credit card bill, you can borrow that much more money again. Mortgages and car loans are not revolving credit because you borrow the entire amount at the beginning. Paying part of your car loan does not allow you to borrow more money.
The ratio of your used to total revolving credit is easy to calculate. Divide the total balances (the amounts that you owe) on all of your revolving accounts by the total credit limits (the amounts that you’re allowed to borrow). If you have a total balance of $10,000 and credit limits totaling $15,000, you have used 66% of your revolving credit. This is very high and will hurt your score.
Length of credit history refers to how long you’ve had credit. A longer credit history will help your score. The average age of all your accounts is important, as is the age of your oldest account. Old accounts help your credit score, while new accounts hurt it.
New credit refers to the number of times you’ve applied for credit within the last 12 months. Applying for credit, whether you get it or not, hurts your score for the 12 months after the application.
Types of credit used is fairly easy to understand. Installment loans, such as mortgages and car loans, require you to pay the same amount each month for a certain number of months. Revolving accounts, such as credit cards, let you choose how much to pay each month (as long as you pay at least a minimum amount). Installment loans help your score more than revolving accounts.
How can I get and keep a great credit score?
The best way to get and keep a great credit score is to use credit responsibly. Obtain credit early and build up a long history of on time payments. Don’t use credit cards to buy things that you could not afford to pay for with cash. Pay extremely close attention to due dates, as a single late payment can cause a significant drop in your score. Do not apply for credit unnecessarily, such as when a store offers you a discount or a free gift.
I’ll share with you the strategy I used to get a great credit score. If you are going to attempt to follow the same strategy, consider how diligently you can monitor due dates and payments. Consider whether you are capable of responsibly using a credit card or are likely to charge more than you can afford to pay. Also be aware that it may be more difficult than you anticipate to obtain a credit card at age 18.
On my 18th birthday, I applied for and received 2 credit cards. Every month since, I have charged at least a small amount (ex: gas) to each card each month. I paid each bill on time each month. I have never closed either of the accounts. As soon as I could afford to, I bought a car and took out a loan with payments I could comfortably afford. I paid the loan on time each month until I paid it off.
How can I find out my current score?
Your FICO Score is calculated based on data from a credit report about you. Federal law entitles you to one free copy of your credit report each year from each of the 3 major credit reporting companies. annualcreditreport.com is the official site to get your free reports. You are under no obligation to buy anything to get your free report (but they will try to sell you stuff). Offers of free credit reports everywhere else have a catch.
Your FICO Score is not part of your free credit report. The company that calculates your FICO Score will sell you a copy of one of your credit reports and the FICO score calculated from that report for $16 (as of 12/3/2008). You can buy this at MyFICO.com.
If you choose to buy your FICO Score, be careful to buy the correct product. There are numerous promotions for “free credit reports” and “free credit scores” on the site; however, they require you to sign up for paid services that automatically renew. The $16 product is a one time purchase.
Where can I go to learn more about credit?
The Motley Fool provides reliable advice on many financial topics. Their section on credit and debt can guide you in the right direction. The sites sells a few products, but you don’t need to buy anything to read the information.
MyFICO.com is run by the company that calculates your FICO Score. It has a lot of helpful and accurate advice about how to get and keep a good score. There are many products marketed on the site, but you don’t have to buy anything to read the advice.
The New York Times has an excellent article on credit scoring.
