Anytime a consumer elects to finance the purchase of a product or service, the terms of the repayment agreement are greatly
affected by your FICO (credit) score. The FICO system is a credit scoring system created by the Fair Isaac Corporation and has been adopted by credit reporting services and lenders worldwide. The FICO score is typically the largest part of a credit decision process but not the only thing taken into consideration. Also,
your score is not considered for purchases alone. Employers, landlords, insurers and utility companies also consider this score as an indicator when deciding whether to do business with you.
The power of your credit score significantly influences the interest rate at which the consumer can borrow money or borrow
money at all. The scoring is from 300, the lowest score possible, to 850, the best score possible. Currently a score of 720 is a typical score for American consumers and represents the score a consumer should achieve. Anything lower means that you are falling short of the preferred American consumer and can expect to pay more in interest and deposits.
The Fair Isaac Corporation is a for-profit company and as such, is certainly not going to share its formula to the public. They do however; offer some basic guidelines for how the score is calculated:
Payment history – 35%
Amounts owed – 30%
Length of credit history – 15%
New credit – 10%
Types of credit used – 10%
It is interesting that many of the activities that contribute to a good credit score actually contradict what is taught by financial counselors. For example, keeping a zero balance in charge accounts is considered wise by a financial counselor but this same activity could negatively impact your FICO score. Also, according to the FICO system of scoring, it makes more sense to have $1,000 balance with 5 credit accounts with a $2,000 limit (total of $5,000 debt) than to have a $5,000 balance with 1 credit account with a $5,000 limit. Having many open accounts is good but having no accounts open is bad.
No matter the logic behind the scoring, the power of your score is in the high number and if you are looking to get favorable interest rates, you will need to take the steps necessary to influence the outcome.
Graphic Source: Lamb, Lori. Credit.org 22 Jan. 2014.