My bank recently started to provide free FICO scores. It’s a great benefit, but honestly, I had no idea what my FICO score was until recently. Since I don’t carry debt and consistently pay my bill balances on time, I assumed I had a score of 850. Much to my chagrin, it was actually 813.
I thought there had to be some mistake. As I began digging deeper, I found that I essentially face a penalty by not having any loans.
I guess I shouldn’t be too upset. Dave Ramsey famously brags that he does not have a FICO score since he doesn’t use credit cards or loans.
Since I didn’t know much about credit scores, I started doing some research on it.
The History of Credit Scores
Before traditional credit scoring came along in the 1950s, banks and lenders would assess potential customers based on relationships. This meant you needed to know your banker fairly well, and he or she had to be familiar with your payment history.
Because of this, assessments were much more character-driven than quantitative-driven. Even if you had a great credit history, a banker or lender that didn’t care for you could easily deny your loan.
As most of you would assume, this led to disenfranchisement for certain individuals who otherwise would be entitled to loans.
Fair & Isaac
In the 1950s, Bill Fair and Earl Isaac were diligently working to create an automated credit scoring system to reduce the bias of qualitative decisions and instead promote quantitative decision-making by lenders.
Within two years of the company’s start, Fair and Isaac began to sell their credit score idea to banks in the United States and around the world.
They received a big boost in 1970, when the Fair Credit Reporting Act passed, regulating what information could be collected and reported by lenders on their customers. In turn, this act created a standardized way to review and enhance the collection of data.
The actual FICO score that we are all familiar today with was not created until 1989.
Today, the three main credit bureaus are Equifax, Experian and TransUnion. Each one of these credit bureaus uses a slightly different proprietary scoring system to determine your score. When aggregated together, they generate your FICO score.
The Components of Your FICO Score
Although the exact formulas are secretive and proprietary, FICO has disclosed the make-up the components of your credit score.
Source: Navy Federal Credit Union
35% of your score is based on your payment history. This means that any bankruptcies, foreclosures, settlements, and even late payments can affect your FICO score.
30% of your score is based on your debt burden. FICO reports that there are six different metrics in the debt category, including the debt-to-limit ratio, the number of accounts with balances, and the amounts owed and amounts paid down on your loans.
15% of your score is based on your credit history. The longer your credit history, the bigger the impact it has on your FICO score. There is a focus on the age of your accounts and specifically the age of your oldest account. This is why some financial experts advise against closing your oldest credit card accounts.
10% of your score is based on the type of credit used. Whether, it’s a mortgage or credit cards, having different forms of credit shows the lender that you can handle different types of debt.
10% of your score is based on credit inquiries. When you have many inquiries on your credit, it can hurt your score. However, do not fret if you are shopping for a mortgage, auto, or student loan. These loan inquiries do not count against your FICO score if they are less than 30 days old, and they have no effect after the first year. Also, if you are out looking for a new job and a potential employer inquires on your credit score, that is a “soft inquiry”, and FICO does not consider it.
FICO Score Ranges
Currently the average FICO score is 700, which means that most Americans fall into the “Good” credit rating. Based on the chart below, you can see the FICO score ranges along and the corresponding impacts.
|Credit Score||Rating||% of People||Impact|
|300-579||Very Poor||17%||Credit applicants may need to pay a fee or deposit, and applicants with this rating may not be approved for credit at all.|
|580-669||Fair||20.2%||Applicants with scores in this range are considered to be subprime borrowers.|
|670-739||Good||21.5%||Only 8% of applicants in this score range are likely to become seriously delinquent in the future.|
|740-799||Very Good||18.2%||Applicants with scores here are likely to receive better than average rates from lenders.|
|800-850||Exceptional||19.9%||Applicants with scores in this range are at the top of the list for the best rates from lenders.|
While my wife and I are not at 850, we are happy to be in the “Exceptional” category. We are thankful to be able to tap into some of the best rates in the future if we need to.
I received compensation in exchange for this article.