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The FICO score was developed from software made by the Fair, Isaac and Company. Lenders can obtain the FICO score from the three major credit reporting agencies namely Equifax, Experian, and TransUnion. For including the FICO score in an individuals’ credit report, it must contain an account that has been open for 6 months or longer. The report must also contain an account that has been updated in the past 6 months. This is done to ensure that there is some recent credit history information needed to create the FICO score.
While most people understand the importance of maintaining a high credit score (FICO), few understand the makeup of the FICO score. The three-digit number is based on a variety of factors. The complete formula is proprietary, so some of the formula remains a mystery; however, the largest factors are well documented. It is recommended that consumers focus their attention on the following five items in particular, when they are trying to understand or improve their FICO score.
The largest component of the FICO score is payment history. This factor accounts for thirty-five percent of the FICO score. It reflects whether an individual’s bills were paid on time. The second most important factor in determining a FICO score is the amounts owed, or credit utilization which accounts for thirty percent of the FICO score. This is basically a ratio comparing the amount that an individual owes to their total available credit. The ratio reveals how much an individual is using, on a monthly basis, or their total available credit.To understand this ratio consider the following example. An individual has three different credit cards, one with a limit of $1,000, one with a limit of $5,000 and a third with a $10,000 limit. The total available credit would be $16,000. If the individual carries a $100 balance on the first card, a $500 balance on the second card and a $1,000 on the third card, their outstanding balance would be $1,600. This would mean their credit utilization percentage would be calculated by diving $1,600 by $16,000, resulting in ten percent.
In order to maintain a high credit score, an individual should strive to keep their credit utilization under thirty percent. To maintain the highest score it is recommended that the credit utilization should be ten percent or less. An individual can improve their credit utilization ratio by either paying down existing debt or obtaining an additional credit source, which would increase their total available credit.
In addition to these two factors, which together account for sixty-five percent of an individual’s FICO score, three smaller factors are also important. The length of your credit history is factored in at fifteen percent of your credit score. As a rule of thumb the longer your credit history, the higher the score. Consumers should consider this fact when deciding to close existing accounts. It may prove beneficial to their overall score to maintain older accounts to maximize their credit history.
Contributing ten percent of the FICO score is new credit. This factor includes the number of recent credit inquiries as well as the amount of recent credit opened. Included in this factor is the establishment of a positive payment history, if there have been problems with payment history in the past.
The final significant factor is the types of credit used. This accounts for an additional ten percent of the overall FICO score. Creditors like to see that an individual can be responsible when managing a variety of credit types. A good mix would include mortgages, credit cards, installment loans, and retail charge accounts.
While there are a number of other factors which contribute to an individual’s FICO score, these five areas are the ones with the greatest influence. If consumers understand the makeup of the FICO score, they will be able to develop a plan to maximize their score. This will result in more available credit options and significantly lower interest rates.
In summary, the FICO score is made up of
1. Payment History – 35%
2. Amounts Owed/Credit Utilization – 30%
3. Length Of Credit History – 15%
4. New Credit/Credit Inquiries – 10%
5. Types Of Credit Used/Credit Diversity – 10%
