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FICO Scores

Introduction to Credit Scores

The first thing that comes to mind when most people think about their credit is their “credit score”.  Just what is a credit score?  A credit score is a number that is calculated as an attempt to “grade” or rank your creditworthiness. The score is used by banks, lenders, utility companies, phone companies, and other businesses that are trying to decide whether you will be a good credit risk for them.  Put simply, companies use the number to decide if you will pay, and whether you will pay them on time.

Put yourself in a bank’s position.  How can they possibly evaluate thousands of loan applications from tens of thousands of people they don’t know, and figure out who is going to pay them back, and who isn’t?  It seems like an impossible task.  One approach would be to personally interview every loan applicant, and talk to each applicant’s friends and relatives to find out about the applicant’s credit reputation. 

That might work ... in the 1800’s. 

Now, it’s simply impossible to do this for every loan or credit application.  The solution has been to use credit scores as a grade or indicator of a person’s credit reputation.  The lender simply pulls a credit report for each applicant and uses the credit score to decide if a customer is a good or a bad credit risk.

So what makes up your credit score?  What goes into this magic number that allows lenders to decide if you are credit worthy?
Credit Score Components The most widely used credit score is the “FICO score” created by Fair Isaac Corporation.  Lenders use FICO scores to help them make billions of credit decisions each year.  FICO scores are based solely on information in consumer credit reports. 

Your credit score is made up of a number of different components.  All of them are related to actions you make (or don’t make).  Two of the largest factors that go into your score are (1) the amount of debt you currently have, and (2) your payment history.  The amount of debt you have is relevant as it may show that you either have room to take on more debt, or you are “maxed out” and probably couldn’t safely add more debt and pay another lender.  Your payment history is relevant because it tends to show whether you have a history of paying your creditors on time (or, whether you have a history of late payments).

To learn more about how your credit score is calculated, how it is used, and how you can improve it, read more articles in this series.

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