When Melissa, a 24-year-old marketing manager from Manassas Park, Va., applied for a loan to buy her first condo, the news from her loan officer wasn’t good. “He told me my FICO score was in the low 600s, too low to qualify for a mortgage,” she said.
Like many first-time borrowers, Melissa was unfamiliar with the power of her own credit history. “I had some random store credit cards I had taken out in college. When I moved, I forgot to forward my address and so I had overdue balances that weren’t paid.”
FICO Score is Key
Lenders look at several factors – your income, employment record and savings when granting credit. But as Melissa found out, when applying for a loan, your credit score can make or break the deal.
Your credit score measures your credit worthiness – the likelihood you will repay your debts. Credit scores are based on a numeric computation of the data contained in your credit report. There isn’t one universal credit scoring system – credit reporting agencies and lenders also have their own credit score models – but when you’re applying for credit, a good FICO score is big.
FICO is short for the credit score system offered by Fair Isaac Corporation, the company that invented the credit risk score model most widely used by the financial industry.
Peter Bielagus, author of Getting Loaded: A Complete Personal Finance Guide for Students and Young Professionals, says, “FICO isn’t the end-all number, but it is a quick fix, much in the way a GPA doesn’t describe the whole student but carries enough weight to make you study harder.”
FICO scores range between 300 and 850. The higher the number, the better risk you represent to lenders.
Your credit score not only determines whether you get credit, but under what terms. With a lousy credit score, you might not qualify for the best credit card or auto rate. You may have to pay extra points on a mortgage or, like Melissa, not qualify for credit at all.
According to Bielagus, “A good FICO score of 750+ can mean your interest rate on a home loan will be 4 percentage points lower than someone with a 500 score. This can mean over $200,000 in saved interest on a house.”
While the exact mathematical formula for determining FICO is a closely guarded trade secret, in terms of broad categories, approximately 35 percent is based on your payment history and 30 percent is based on your level of outstanding debt. So paying bills on time and not overextending yourself go a long way in improving your credit score. Length of credit history, new credit, and type of credit – a healthy, modest mix of credit cards and installment debt is good – are the other categories. And as new information is added to your credit report, your credit score changes.
Know Your FICO Score
You need to know your score to improve it. For Melissa, that meant pulling her credit reports, contacting her creditors and paying off her overdue balances. Working with her loan officer, she eventually did get her mortgage.
Consumers actually have three FICO scores, and each FICO score is based on the data from one of the three national credit reporting agencies: TransUnion, Equifax, and Experian. You can buy one or all of your FICO scores along with the corresponding credit report and view it online at www.myfico.com for $13 each. For $15, you can also order your credit report and a credit score directly from the credit agencies at transunion.com, equifax.com and experian.com.
Credit control is cool. And knowing your FICO score is a powerful financial tool that will help you develop good money habits and manage your credit responsibly.
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