If you’ve ever applied for a credit card or a loan, you’re probably familiar with your FICO Score. Over 90% of top lenders use your FICO Score as part of their lending decision according to its creators, the Fair Isaac Corporation. That’s a big percentage. So why is your FICO Score so important to them?
Your FICO Score is what lenders use to determine your potential risk factor. That is, whether you are more likely to pay them back (low risk) or more likely to default on your payments (high risk). Your FICO Score is calculated using data collected from your credit report. Scores range from 300 to 850. The higher you are able to boost your score, the lower risk you’re considered to be. Read on to find out why your FICO Score is important and how you can improve yours.
Having a high FICO Score reassures lenders that your track record has shown that you are likely to be able to keep up with your obligations to them. In return, they’re able to offer you their best interest rates and repayment terms. Being approved for credit under better terms can save you thousands of dollars, improve your overall financial health, and put you a step closer to achieving your personal finance goals.
Not only does a good FICO score give you access to the best financial options out there, but auto insurers and property management agencies also evaluate your FICO score. This means a higher FICO score can get you to lower auto insurance rates and improve your chances of being approved for that place you’re hoping to rent. If homeownership is something you’re hopeful for, a good FICO score can also help get you there.
You may not know that you have more than one FICO Score. The Fair Isaac Corporation regularly updates the formulas they use to calculate FICO Scores and create new versions. Some versions are industry-specific and some are newer, like FICO Score 9. For more information, check out Fair Isaac Corporation’s website.
For the purpose of this article, we’re going to focus on the FICO Score formula most commonly used by lenders — FICO Score 8. Below we’ve provided a breakdown of the factors that make up your FICO Score 8 and the impact each of those factors has on your overall credit score.
Payment history (35%): Your payment history is the most important factor in your FICO Score. Lenders want to be sure that you can make your payments on time. If you have consistently made on-time payments to previous lenders, you will likely be able to make your payments to them.
Credit utilization (30%): The second most important factor in your FICO Score is how much of your available credit you’re using. If you’re using a large portion of your overall credit, lenders may perceive you as being overextended and at risk for defaulting on payments.
Length of credit history (15%): Lenders want to know the average age of all of your credit accounts, the age of your oldest and newest accounts, and when you last used your accounts. Showing consistency over the long term is important for demonstrating your ability to be consistent going forward.
Credit Mix (10%): There are different types of credit. Most credit accounts fall under one of two major categories: revolving or installment. Revolving credit accounts include credit cards, retail cards, and lines of credit. Installment accounts include things like auto loans, personal loans, and mortgages. Lenders like to see that you’ve demonstrated an ability to manage different types of credit accounts.
New credit (10%): Every time you open a new credit account, it shows up on your credit report. Opening too many new accounts over a short period of time may mean that you’re taking on more than you can handle. This could mean that you’re at risk of defaulting on your payments to them.
Something to consider when you’re thinking about these factors is that your own credit profile is unique and lenders also look at other factors when making their lending decision, like your income and how long you’ve been with your current employer.
Now that you know what’s included in your FICO Score, you’re probably wondering what you can do to improve yours. We’ve got you covered. Below we’ve provided some of the best recommendations out there.
You’ve gotta start somewhere. The first step to improving your credit score is knowing what it is and monitoring it regularly. You can do this by signing up for a free credit-monitoring service like Credit Karma or a paid credit-monitoring subscription service like PrivacyGuard. It’s important to keep in mind that these services provide very close estimates of your FICO Score, but they are not actual.
There are a few different ways to get your actual FICO Score, you can sign up at freecreditscore.com or see if your credit card company provides you with access to it as part of your cardholder benefits.
Checking your credit report regularly will help give you an idea of where you’re at, set goals, and catch any errors that need to be corrected.
According to the Federal Trade Commission, five percent of consumers have errors on their credit reports that could result in less favorable loan terms. These errors could negatively affect your credit score. If you find any when reviewing your credit report, be sure to dispute them. You can do this by submitting a letter or an online dispute to the credit bureaus. It may take up to 45 days to receive a response from the credit bureaus. Assuring that your letter is as detailed as possible will help expedite the process.
The single most important thing you can do to boost your credit score is to make your payments on or before their due date. Life is busy and it isn’t always easy to remember to pay your bills on time, but missed payments can stay on your credit report for up to seven years. Setting up automatic payments can be really helpful to keep you on track. If you do this, make sure you have enough money in your bank account on the day that the payment is due to avoid late fees from your lender or overdraft and insufficient funds (NSF) fees from your bank.
If you do miss a payment, get in touch with your creditor as soon as possible to make them aware of the situation. Maybe you got paid less this month because you were short on work hours due to illness, or you simply missed your due date because you had something going on in your life. They may have the ability to remove the late mark from your report if you have a legitimate reason and make your request in a timely manner.
A large part of your FICO Score weighs on how much of your available credit you’re using. This is specific to your revolving credit accounts. As a guideline, experts recommend using no more than 30% of your credit card balances (the less you use, the better). This Nerdwallet article explains how you can calculate your credit utilization ratio.
If you’re already using 30% or more of your available credit and it will take you some time to pay down your balances, one other way to consider improving your credit utilization ratio is by increasing your credit limits. This may or may not be an option available to you. If you’re a long-time customer who pays on time regularly and your income has increased since you first opened your account, you have a good shot. What you’ll need to do is get on the phone with your creditor to see if they’re able to increase your credit limit. Be careful not to increase your credit limit if you have trouble controlling your spending or this could put you into more debt and lower your credit score in the long run.
Another strategy to consider for improving your credit utilization ratio is to consolidate your debt. This is tricky because there are negative impacts to consolidating your debt (new credit inquiries, a new account opened, and a possible reduction in your average account age), but overall it could be a good option to consider if you can reduce your interest rates, lower your monthly payments, and make your payments on time. This also increases your overall available credit.
Once an account is sent to collections or charged off, it will remain on your credit report for 7 years. Try to pay your accounts off before they enter into those statuses. If they do get to that point, it’s still worth paying them off. Lenders are less likely to approve you if they see unpaid balances on your credit report.
Student loans have a long repayment period, so paying them on time, over time, is a great way to increase your credit score. Student loan payments also offer a little more flexibility in their reporting. Federal student loans are reported late 90 days after a payment is due, while private student loans are reported late 30 days after a payment is due. Forbearance and deferment plans may also be available to temporarily put your payments on hold without impact to your credit score. Make sure to keep in touch with your student loan providers and know what options are available to you.
If you have never had a credit card or loan and you have no credit history, lenders may be unwilling to take a risk on approving you. One option to consider if you’re trying to build credit is to request to be added as an authorized user on your parent, spouse, or a close family member’s credit account. Be sure that it’s someone you trust and who trusts you. Come to an agreement with them on what you can spend and what you will contribute every month toward their payment. When they make their payments on time, this will also reflect positively on your credit report. This is something you have to be really cautious about, however, because if their payments are not made on time, it will reflect negatively on your credit report. Once you’ve established some credit history, you should be able to move off of their account and get an account of your own.
Utility companies do not report your on-time payments to the credit bureaus by default. In the past, utility accounts were not included in credit reports because they aren’t credit accounts. This is beginning to change as it becomes evident that consumers should be recognized for making these payments on time. Now, you can have certain utility bills, like your phone bill, reported on your Experian credit report by using their Experian Boost tool. This will only affect your Experian report, but it’s still worth a shot as some lenders may find it helpful.
A good FICO score is important to your financial health and it’s achievable, but it won’t happen overnight. It takes knowledge, creating good habits, and consistency over time. Play it smart and you’ll get there.
And if you’re looking to rebuild credit, check out Possible Finance. Because it’s an installment loan and repayments are reported to all 3 major credit bureaus - TransUnion, Equifax, and Experian - you’ll build a positive credit history with on-time payments.