What you need to know about your FICO score and how to build good credit

Caroline Lupini

Aug 8, 2019, 22:38 IST

What you need to know about your FICO score and how to build good credit

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Your FICO score may be slightly different at each credit bureau.

FICO is the numeric credit-scoring system created by the Fair Isaac Corporation; it's the first and most-used credit-scoring system in the US.
All three credit bureaus - Experian, TransUnion, and Equifax - use the FICO system, though other credit-scoring systems exist. Your FICO score may be slightly different at each bureau depending on what information they have about your credit history.
Several factors go into establishing your FICO score (aka your creditworthiness), including your payment history, payments owed, length of credit history, age of accounts, and more.
Check your credit score through Experian, TransUnion, and Equifax »

If you've applied for a credit card, loan, or even an apartment in some regions, you're probably familiar with your credit score, the one you can look up for free on Credit Karma, Credit Sesame, and through some banks and money apps. (You're entitled to a free copy of your credit score from each credit bureau every 12 months and can get them at AnnualCreditReport.com.)

Your credit score helps financial institutions and lenders determine your creditworthiness and set interest rates or loan terms that correspond to your score. Credit scores range from 300 (extremely poor, very limited credit opportunities) to 850 (excellent credit opportunities) and fluctuate based on a variety of things, such as late payments, debt-to-credit ratio, accounts in collections, the age of your credit accounts, and more.

The three credit bureaus - Experian, TransUnion, and Equifax - each establish a credit score for consumers based on your purchase and payment history, and those scores uses the FICO scoring system.

What is a FICO score?

FICO is an acronym for the name of the company that first created the numeric credit-scoring system, Fair Isaac Corporation; FICO estimates that about 90% of lenders use its scores to help decide how much credit to extend to consumers. It's worth noting that while every credit bureau uses the FICO system, not every credit score is a FICO score - other scoring systems exist, such as VantageScore.

Your FICO score may be different at each bureau as each agency may have slightly different information about your credit history (though it should be fairly similar - if you notice a big discrepancy, call the bureau to find out what's going on) and you can have more than one FICO score at one agency depending on what type of loan you've applied for.

As of September 2018, the average FICO score for a US credit holder hit (and exceeded) 700 for the first time, suggesting that consumers are becoming more aware of the dynamics of holding and building credit, are making fewer delinquency mistakes, and are making smarter decisions for their financial health.

The best way to make those decisions is to understand what goes into your credit score in the first place. Let's take a look at those components, and what they could mean for your credit. Here is a little bit of information about the what kinds of things contribute to your credit score, what might account for a sudden drop, and how you can intentionally work to improve your credit over time.

Payment history

The exact FICO scoring system is a closely guarded secret, but we know that the most substantial part of your FICO score is your payment history. This is perhaps the most obvious - if you are consistently delinquent in your payments, your credit will suffer. This part of your score is based on your late and on-time payments, as well as any bankruptcies on your credit file.

Amounts owed

Your balances owed account are another significant portion of your FICO score. While using credit wisely (e.g. paying off your credit card balance in full every month and not charging more than you can afford) can help to build your credit score, a high debt-to-credit ratio can hurt your FICO score.

The term debt-to-credit ratio refers to the amount of money you owe compared to the amount of credit your lenders have extended to you (your credit limit); your debt-to-credit ratio should never exceed 30% to keep your credit score in good shape, though hovering around 1 to 10% is best.

Other factors considered here are what percentage of your mortgage or car loan you've paid off, and how many of your accounts have balances.

Length of credit history

If you are a new borrower, don't expect to start with a perfect 850 credit score. On the contrary - it is your responsibility to prove your creditworthiness, and you're basically starting from scratch. As you establish your accounts and make payments on time, your credit score will improve.

Whether you're new to the credit game (a young person, for example, or a new immigrant) or have a long credit history, it can be a good idea to hold on to healthy old credit accounts even if you aren't planning to use them anymore to help avoid sudden changes in your credit score. Closing accounts that have established and upheld your FICO score can end up lowering your score.

Some accounts don't officially erase themselves from your credit for at least one year, either, but if the account is paid in full, leaving it alone without closing it can keep your credit score healthy (so long as you're not paying an annual fee just to keep your account open).

Types of credit

There are two main types of credit: revolving credit and installment credit. Installment credit is essentially a loan that is no longer available once it is paid off. For instance, if you take out a loan from the bank, that loan does not replenish itself once you have paid it in full; this is installment credit.

The second type, revolving credit, is credit that does become re-available once it is repaid. Credit cards are revolving credit because you can pay them off but then use them again immediately.

Diversifying your credit is a healthy strategy as long as you can keep track of payments and interest rates, and this can be done through mortgages, retail accounts, credit cards, and more.

New credit

The amount of times a credit inquiry is ordered on your account affects your credit score, as well as the number of new credit lines you open.

Opening a new account before getting a handle on old accounts can adversely affect your credit score because it increases the amount you've borrowed, even if it hasn't been spent yet. On the flip side, opening credit lines is necessary to establish credit in the first place. So it is good practice to open a new line of credit only if that line offers benefits that outweigh the adverse effects, you are on schedule with payments, and you will be able to stay on schedule with the new line.

A few things to keep in mind as you're building your FICO score

First and foremost, avoid payment delinquency at all costs. Pretty much everyone misses a payment at some point, but most banks and lenders now have automatic, paperless payment options that allow consumers to set up payment plans in just a few minutes. Take advantage of those options if you tend to be a bit on the forgetful side, because missed payments can become huge blows to your credit score and even prevent you from being approved for credit lines in the future.

Pay attention to interest rates and any potential annual fees, and avoid paying too much interest on your loans by carrying a balance of 30% or less.

It is good to eventually diversify your credit to build creditworthiness across the board, but begin with just one or two lines to get established. It is easy to get sucked into the credit card game because of the potential to earn great rewards, but you don't want to lose control.

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