Have you ever wondered how FICO credit scores are determined? Better yet, have you tried to explain the process to your children in an effort to prepare them for their own financial futures? It’s important for you (and your children) to understand FICO credit scores because insurance firms, landlords and even employers can use them as a way to determine your level of responsibility. Here’s an overview to help you make sense of FICO credit scores.
The history of FICO
In 1956 engineer Bill Fair and mathematician Earl Isaac founded Fair, Isaac and Company and two years later launched its first credit scoring system for American investors. The company’s name was changed to the Fair Isaac Corporation in 2003, and then to FICO in 2009. FICO scoring has become a fixture of consumer lending in the United States. It went public in 1986 and is traded on the New York Stock Exchange.
What does a credit report reflect?
Your credit report is a track record of your payment history and whether you’ve paid your bills on time. Your credit score is calculated based on what’s in your credit report.
What is a credit score?
Think of your credit score like a school GPA. It’s a cumulative number that is used to measure your credit-worthiness in relation to others.
FICO scores can range from 300 to 850. Your credit score is generated based on the information in your credit report and lenders will assign interest rates based on which bracket your score falls into. Generally, anything over 740 will qualify you for the best rates. Scores below 650 will result in higher rates, and often times will completely disqualify you for any credit.
The following is taken into consideration when calculating credit scores:
- How much you owe.
- The amount of credit you have available to you.
- The length of your credit history to determine how long it’s been since you’ve used your accounts.
Things that can hurt your credit score:
- Opening a lot of credit accounts at once and the number of new accounts you have.
- Paying your bills late. The later you are, the worse it reflects on your score.
- Having bills that have been turned over to collection agencies.
- Having credit cards that are maxed out (or close to it). This may suggest that you are more likely to miss your payments.
- Debt settlements, bankruptcies, foreclosures, liens or judgments against you.
Things that can help your credit score:
- Paying your bills in a timely manner.
- Having a mix of different types of credit accounts. This shows lenders that you can successfully manage different credit accounts.
- Not using all of your available credit.
- Owing less than the original amount on your installment loans.
- The length of your use of credit and the average age of all your accounts (provided you have been paying on time).
Credit scores are used to predict the “grades” of potential borrowers. Besides your credit score, potential lenders will also look at your income, how long you have worked at your present job, and the kind of credit you are requesting. FICO scores are available through all of the major consumer reporting agencies including Equifax, Experian, and TransUnion.
According to MintLife.com, your FICO score is your “financial fingerprint” and will essentially become “your financial DNA”. As a parent, you need to understand how credit reports and credit scores work and effectively teach your children the same, so they can successfully navigate their future financial journeys.
FamilyMint is dedicated to helping parents improve financial literacy through their fun, educational, intuitive, and award-winning online money management application. FamilyMint has helped thousands of parents raise money-smart kids by teaching children about financial goal setting, and forming the types of financial habits and behaviors that will lead to financial success.