Many experts believe that borrowing will continue to be tight in 2009 unless the government does something to loosen the credit markets at the consumer level. This means that it will be increasingly difficult to get favorable interest rates on consumer loans including mortgages, auto loans, and credit cards unless your credit score is among the highest. According to Fair Isaac, the company that created the FICO credit score, those with a score in the range of 760 - 850 should receive the most favorable interest rates when looking to borrow. During the past year the bottom end of this range has increased by roughly 20 points as credit markets tightened up.
While your FICO score is only one factor used by creditors to make lending decisions, it is used widely by lenders as an indicator of your overall credit history. Understanding your FICO score and it components is critical to improving or maintaining your ability to borrow.
FICO scores range from 300 to 850. In general, the higher your score is the more favorable the interest rates available to you when you apply for a loan or for credit. An example from Fair Isaac illustrates the significant difference in the average interest rates available to those with a FICO score in the 760 - 850 range versus those with score in the 500 - 579 range. The average interest rate as of Nov. 24, 2008 for a $300,000 dollar, 30-year fixed mortgage in Massachusetts is 5.652 percent for those with a score in 760 - 850 range compared to 9.931 percent for those with a score in the 500 - 579 range. This difference in interest rates means higher monthly payments of $885 dollars for those with a FICO score between 500 and 579.
Your FICO score is composed of the following five general categories:
1) Payment History – Represents your payment history as well as delinquencies and adverse public judgments such as bankruptcies and liens;
2) Amounts Owed – Represents the balances owed on your current accounts as well as the outstanding balance of any credit line (relative to the amount available in that line);
3) Length of Credit History – Represents the amount of time since your accounts were opened and the frequency of the activity in your accounts.
4) New Credit – Represents the number and timing of newly opened accounts and the frequency of inquires made on your account by prospective lenders and creditors.
5) Types of Credit – Represents the different types of accounts you use such as mortgages, credit cards, student loans, etc.
The importance of each category differs for each person depending on their general credit profile. For example, your payment history may be weighed more heavily in the computation of your FICO score if you have a long credit history as opposed to if you have a short credit history. For the general population, Fair Isaac says that the five categories are weighted as follows: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and types of credit (10%).
You generally need to pay to see your FICO score. However, each year, you are entitled to receive a free copy of your credit report from each of the three credit reporting companies (Experian, TransUnion and Equifax). You can request your reports by going to www.annualcreditreport.com. While your credit reports will not necessarily show your FICO score, your score is based on the information in these reports. Monitoring and correcting the activity in these reports will improve your FICO score.
Understanding how your FICO score is important to your overall financial health. There are many ways to improve your score but keep in mind that most of them take time to accomplish. Visit Fair Isaac’s web site at (www.myfico.com) to learn more about how the FICO score is computed and how you can improve your score.
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