You've probably heard the term "FICO score" thrown around on more than one occasion. You may have even seen yours listed on a bank or credit card statement. But what is your FICO score used for? And are your FICO score and credit score the same thing?
A FICO score is a type of credit score used by lenders to determine whether you should be allowed to borrow money. The name "FICO" is an abbreviation of Fair Isaac Corporation, which is the company that originated this particular scoring method. Though there are other types of credit scores out there, most lenders use FICO scores to determine creditworthiness, and as such, the terms "FICO score" and "credit score" have come to be used interchangeably.
How are FICO scores determined?
There are five key factors that go into establishing a FICO score:
- Payment history (35%): Your payment history is a measure of how responsible you are about making payments. Consistently paying your bills on time will boost your score, but making payments late, or missing them entirely, will hurt your score in a very big way.
- Credit utilization ratio (30%): Your credit utilization ratio is the percentage of available credit you're using at any given time. A ratio that exceeds 30% can bring down your score, so if you have a total of $10,000 in available credit, you should try not to owe more than $3,000 at once.
- Length of credit history (15%): Your credit history refers to the amount of time your oldest account has been open. Having long-standing accounts can work in your favor, especially if you've been current on your payments.
- New credit accounts (10%): Opening too many new accounts simultaneously can hurt your FICO score. Every time you apply for a new account, you'll get a hard inquiry on your record, which can bring down your score.
- Credit mix (10%): Your credit mix speaks to the variety of account types you have. "Variety" is the keyword; having a mortgage, an auto loan, and a single credit card will lift your FICO score more than having multiple credit cards.
As you can see, some of these factors carry more weight than others. Knowing which ones to focus on can help you take steps to build a better FICO score.
Why your FICO score matters
Your FICO score is what lenders use to evaluate your creditworthiness, and if your score is poor, you may have trouble buying a home, renting an apartment, securing an auto loan, or getting approved for a credit card. In fact, in some situations, having too low a score might impact your ability to get a job. On the other hand, if your FICO score is strong, you're more likely to get approved for a mortgage or other type of loan, and you'll be offered better interest rates. You're also more likely to snag the best credit card offers out there, which opens the door to superior perks and rewards programs.
Improving your FICO score
While you don't necessarily need to have excellent credit to get approved for a loan, the better your FICO score, the more flexibility you'll have when it comes to borrowing money. FICO scores can fall anywhere between 300 and 850. Generally speaking, a score of 800 or above is considered outstanding, while a score in the mid-to-upper 700s is considered very good. Things get iffier, however, as your score falls below 700. A score in the low 600s, for example, is considered fair, while anything under 580 is considered poor.
If you're not happy with your FICO score, one of the best ways to improve it is by getting in the habit of paying all of your bills on time to boost your payment history. You can also work on paying down a chunk of your existing debt to lower your credit utilization ratio.
Contrary to what you may have been told, earning more money won't do anything to improve your FICO score, nor does the amount of money you have in your bank account impact your score. That said, the more you earn, and the more you save, the easier it'll be to pay your bills and avoid excessive debt, which can help keep your score in an ideal range.
One final thing to keep in mind about your FICO score is that it's by no means set in stone; in fact, it can change in a matter of days, so it pays to check your score at least once a year and make sure it hasn't dropped significantly. The more vigilant you are over your FICO score, the more financial flexibility you'll have across the board.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at email@example.com. Thanks -- and Fool on!
The Motley Fool has a disclosure policy.