Credit Score Part 1: Understanding FICO Score

What Is FICO Score

The acronym FICO stands for Fair Isaac Company, the original creator of the scoring system for a consumer’s creditworthiness. FICO scores are used primarily by lenders to make credit-related decisions such as mortgage, auto loan, credit cards, just to name a few.

The FICO score is based on an individual’s credit history, which is maintained by the three major credit reporting agencies Experian, Equifax, and TransUnion. The FICO scores from the three credit agencies for the same individual can vary. As an example, my credit score with Equifax is 862, but with TransUnion it is 813.

Equifax’s credit scores consist of the following categories:

  • 800 – 900: exceptional (well above the average US consumer’s score)
  • 740 – 799: very good (above the average US consumer’s score)
  • 670 – 739: good
  • 580 – 669: fair
  • 250 – 579: risky

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Source: Equifax and Citi Bank

What Determines Your Credit Scores

In the Equifax credit system, your score is based on payment history (35%), amount you owe (30%), length of credit history (15%), type of credit (10%), and new credit opened (10%). The other two agencies have slightly different scoring methodologies.

Why Your Credit Scores Matter

For most of us, our biggest purchase is our own primary residence (or vacation home or investment property). The biggest cost of making this purchase is the interest cost, which is directly linked to the credit score. The higher the credit score is, the lower is the interest rate and interest cost – everything else being equal.

To illustrate, if you are purchasing a $1,000,000 home and borrowing 80% from a bank (i.e. borrowing $800,000) with a 30-year fixed mortgage, assuming an interest rate is 4%, your total interest cost over the 30-year period is $574,956 or approximately 57% of the purchase price. And if the interest rate is 4.125%, your total interest cost would be $595,791 or approximately 60% of your total purchase price. The difference in interest cost is $20,835 over 30 years. Hence, a very small difference in the interest rate means a meaningful difference in interest costs for a mortgage.

One key factor determining your interest rate on your mortgage is your FICO score. FICO score not only determines interest rate on your mortgage loan, it is also a key determinant of the interest rate of a variety of other debt. In my view, it is absolutely crucial to keep building your credit score.

How to Track Your Credit Scores

To check your credit score you can request a free credit report from one of the three credit reporting agencies here. Federal law allows you to get one free credit report from each of the credit reporting agencies in each 12-month period. Once you receive the credit report, read over the details and review for accuracy. If you see errors, make sure you correct these by following through the steps outlined on this website.

A number of banks (i.e. Citi and Bank of America) also track for your credit scores if you hold credit cards with them. To see your credit score, make sure you credit card is linked to your online account. Below is my historical credit score for the past six months from Citi. I love having the convenience of seeing my credit report when I log in my bank account online.

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Source: Equifax, Citi Bank, Finance Cappuccino

One easy and comprehensive app I have been using is WalletHub. Once you create an account, it will track your credit score, and show how your score compares with those of other Americans, other residents in your state, other people your age, and other people in your income bracket. In addition, it will track the number of credit inquiries you had recently, the number of cards you have, etc. The app also tracks your mortgage loan balance, your credit card balances, etc.

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Source: WalletHub and Finance Cappuccino

In my next post, Credit Score Part 2 – Improving your FICO Score, I will share with you practical tips for improving your credit scores.

 

Dear readers, how often do you track your credit score? What tools/apps do you enjoy using?

Disclaimer: the writer of this post does not receive any financial compensation from the credit reporting agencies, Citi, Bank of America, or WalletHub.

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