That FICO Feeling

So what is this FICO thing, anyway?

In what probably began as a great inside joke meant to keep people totally in the dark about why their credit applications were being rejected, the Fair Isaac Company devised a top-secret, multi-faceted formula that generated a simple credit score to attach to every person's credit report. (You would expect stuff like this from a company whose website bills itself as a "preeminent provider of creative analytics.")

Generally speaking, credit-scoring formulas such as FICO analyze your credit history, income, outstanding debt, and debt utilization over time. Your potential access to credit and other indicators of your financial behavior are also examined to determine how likely you are to pay your bills on time — or if at all.

FICO was intended to allow lenders to make a quick judgement-at-a-glance of a person's credit worthiness. It gives the loan industry a standard ranking system to help them avoid poor credit risks − should they so choose, which, coincidentally, they often don't. (Let's face it: Folks who have trouble paying their credit cards and other loans mean more late fees and more high-interest charges for the loaning agent. And that means more profit.)

Many lenders base their credit decisions on nothing more than the applicant's FICO score; others pay it little attention. Generally, though, the higher your FICO score is, the better the interest rate the lender will offer you. Check out the MyFico.com Loan Savings Calculator to see the difference the FICO score can make for a mortgage interest rate.

Because of this, it pays to get copies of your credit reports from the three credit bureaus (see below) and look them over. Check your FICO score, and do what you can to improve it. (Also, for those who'd like more information on deciphering and improving their FICO scores, Liz Weston's 2005 book Your Credit Score is a tremendous tool for your arsenal.)

(By the way, you might also see other, FICO-like credit scores on your reports: "Beacon" and "Empirica" are Equifax's and Transunion's versions of FICO, respectively. They're on roughly the same scoring scale as FICO, but they likely won't match your FICO. This is because each credit reporting agency employs its own scoring model, and then those models are further tweaked to fit agency- and lender-specific needs.)

Numbers, Numbers, Numbers:
FICO Facts & Credit-Scoring Tidbits

We're told that most consumers' FICO scores range between 320 and 850. According to MyFico.com, the median FICO score in the U.S. is 723.

Here's what Fair-Isaac says comprises the FICO formula:

Or, presented another way:

What's a Good Score?

As a rule of thumb, scores above 650 qualify for the best, lowest-interest-rate loans. Scores in the 620 to 650 range may need to provide extra documentation and explanations to the lender to qualify for the same rates. People with scores below 620 will likely pay the highest interest rates. Scores above 680 will earn the best interest rates available; this is the average "high approval" score.

Plus You Get FICO Variety...

Suppose that one day, you pull your credit score. That same day, you visit a mortgage broker and an auto dealer, and each of these businesses retrieves your score as well. The three scores will likely not be the same.

Credit scores, when accessed by mortgage brokers and car dealers, are tailored by the credit-scoring agencies to be most relevant to those businesses. These "tailored" scores will focus on certain aspects of your credit history more heavily than others. For instance, the score your auto dealer sees will be based more upon your previous payment histories on auto loans, and the score your mortgage banker sees will be calculated with more weight given to your house-payment history. And neither score will likely match the score which you pull yourself.

Getting A Copy of Your Credit Report(s)

It's hard to believe, but true: If you live in the United States, getting your hands on a copy of your credit report is probably free.

Check AnnualCreditReport.com to find out whether your part of the country is yet included in the "one free credit report per person, per bureau, per year" program. Once you're included, it's a good idea to check your credit reports annually — say, by pulling your credit report from one bureau this month, then from another bureau four months later, then from the final bureau four months after that.

Note that these free reports will not include your credit score. They will simply list all your accounts, payment histories, and assorted other financial information. Learning your credit score can be acquired easily enough, too — but it will cost money no matter what. (Usually a single-bureau credit score will set you back somewhere in the range of $8 to $10.)

If you're not included in the free credit-report program above, remember that there are three major credit bureaus which compile all your information. This means there are three different versions of your credit and financial life out there. You can go straight to each of them if you like:

You can also select a third-party source (for example, MyFICO.com) through which to get your report. The benefit here is that you can usually get "combined reports" which show your credit data from all three of the credit bureaus. This will likely cost you around $30.

In my opinion, this is one instance where $30 is more than a bargain — it's a no-brainer.

Your credit score is that important.

Fluffing Up Your FICO

So you've checked your credit score, and it's a mess. What do you do now? Call one of those credit-repair places you hear advertised on talk radio all the time? (You know — it's always the same announcer's voice, but the name of the credit-repair service changes every couple of months. Reassuring, isn't it?)

No, don't call those guys. Here's a better plan:

Use your credit responsibly.

There is no Magic Fix for a beat-up FICO with no A/C and an engine knock. The biggest and most reliable boost to your FICO score occurs when you pay your bills on time, every time, over time.

Check your credit reports annually.

Remember: If you're a U.S. citizen, you're entitled this free of charge. Check for and remove any errors you find.

Keep your debt reasonable.

As a general rule, your account balances should be below 70% of your available credit. Pay down your outstanding balances. Your credit score receives a boost when your balances drop below 70% of the available limit, and yet another boost when they drop below 50% of the limit.

Reduce your debt-utilization ratio.

Your score takes into account how much of your available credit you're actually using; i.e., they tally up your total credit (adding up the credit limits from all cards) and then figure the percentage of it that you're actually using. So be careful about closing credit-card accounts that make up a large portion of your overall credit limit. It can cause your "Percentage of Credit Used" to skyrocket. And that means your FICO score will suffer.

Be patient.

Give it time. The extent of your credit history is a factor in your score. Credit reports with around 30 years are considered optimal. Up to 7 years is considered short, and less than 3 years of credit history is deemed too little.

Don't request new credit lines.

Keep new applications for credit to a minimum. Each time you initiate an inquiry by applying for credit, it can lower your score by as much as 5 points. If a junk mailer checks your credit, though, your score shouldn't be affected, since it wasn't a consumer-initiated application. If you're shopping around for an auto or home loan, then keep in mind that all auto and mortgage applications in any 14-day period are counted as only one inquiry. Inquiries can remain on your credit report for up to two years, but it's those within the last six months that will count most heavily against you.

Every time your credit report is accessed by a potential lender — whether it's for a credit card, car loan, or home refinance — it's likely to count against you and lower your FICO score. Why? Because these inquiries are interpreted as a sign that you have been actively seeking credit, and may be in financial difficulties or in the process of overextending yourself.