The FICO Score as an Indicator of Creditworthiness and Financial Management Skills
FICO is a credit score system that is based on different factors and used by financial institutions to determine the creditworthiness of applicants. It was developed by the Fair Isaac Corporation and accounts for both negative and positive information.
Factors Used to Determine the Score
FICO is based on five categories – type of credit (installment and revolving), new debt, loan amounts, payment history (i.e. late or missed payments), and length of credit history. The payment history is the most important factor, along with loan amounts. Accounts that are included are mortgages, installment loans such as personal, student, and car loans, retail and credit cards like Discover, American Express, MasterCard, Visa, and others. The score also looks at factors such as judgments, liens, and lawsuits. Serious events such as foreclosures and bankruptcies are also taken into account. Missed and late payments play a role, depending on their number, amounts due, whether they are recent, and how late payments are. The amounts owed and the number of accounts are other factors. The fact that someone owes money doesn’t mean that he is a risky borrower. Those who make regular payments have a good credit history. However, a high credit utilization ratio is a red flag which shows financial institutions that the borrower may find it difficult to make regular payments.
Factors That Are Not Included
Other factors are not taken into account, for example, marital status, nationality, religious affiliation, and others. The age of the borrower is another factor that doesn’t play a role. The same goes for your employment history, occupation, income level, and residence. The score does not take into account the interest rates, whether high or low, on loans, home equity lines of credit, and other products. Rental contracts, child support, ethnicity, and race are in the same category.
There are different ranges for auto loans and bank cards and mortgages. The mortgage score, for example, is in the range of 300 and 850. Borrowers with a score of 650 and higher have a good credit history while those with a score of 619 and lower have a fair, average, or poor credit. This means that they are considered risky borrowers, and it is more difficult to get approved for a loan with attractive terms and interest rates. Data about borrowers vary from one bureau to another. Bureaus such as TransUnion and Equifax maintain their own databases.
There are different types of scores depending on the product you are applying for. The general purpose FICO, for instance, is used for various loans. Other scores are used for credit cards, mortgages, and loans.
Ways to Improve Your Score
Obviously, regular payments are important and show that you are a creditworthy borrower. One way to improve your score is to reduce the amount of debt (card balances and loans) owed to different financial institutions. You can opt for payment reminders to make sure that you are current on your payments. Another way to improve your score is to transfer high interest rate balances to a low interest credit card. This will make payments more affordable and will reduce the risk of late payments. You may want to check your report as well. If there are errors, you can ask the bureau to fix them. Provide your address and name, along with documents that prove your case. Make sure you enclose your credit report.
The Importance of the FICO Score
Most financial institutions rely on your report when offering a loan or credit card product. Those with a low score may not qualify. The best travel and rewards cards are reserved for borrowers with an excellent credit history. Small blemishes are not something to worry about. If a late payment is not recent, it won’t affect your score in the same way as a foreclosure or bankruptcy, which are serious events. The score also favors people who have both revolving and installment loans such as credit cards and student, auto, and private loans. When it comes to interest rates offered, those with a score of 620 or lower will get a rate that is 2 points lower than those with a score of 730 or higher.
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