What exactly is a FICO score and how is it calculated anyway?  We all hear time and time again about how important that number is in obtaining a home loan, a car loan, or even homeowners insurance, but what does it consist of? 

 

Interestingly enough, FICO scores have absolutely NOTHING to do with income, in fact, income is never reported to credit agencies.  FICO scores only report how a creditor uses credit. 

 

For instance, a late payment in the last 12 months can lower a score more than a bankruptcy that’s more than 5 years old.  That’s because 35% of your score is based on timely payments of obligations, and late payments that are recent count more than late payments that are older than one year.  Just making timely payments for the next 6 months can raise your score and doing so for one year can raise it substantially.

 

Debt ratios are another large impact on your score.  If you use more than 30% of your available credit on a line of credit, it will negatively impact your score. If you have more than 75% of the available credit used, it will doubly impact your score.  That’s why it’s often more useful for relatives who wish to help their families obtain a home mortgage pay down debts rather than provide a “gift” down payment on the home. 

Present estate tax gift laws allow relatives to give $11,000 per year tax free to as many people as they want.  A couple can give a person $22,000 tax free and one couple could give another two individuals $44,000 per year.  These gifts could be used to pay down some or all of the debts, which would lower the available credit used, increasing the credit scores and reducing the debt ratios of the prospective borrowers. 

 

Another aspect of FICO scoring is the length of time that one has had credit to use, or credit history.  That’s why older people in general have better credit than younger ones.  This is 15% of your total score, so it’s important for young people to establish credit as soon as possible. 

 

Only certain types of credit are reported to the credit agencies: revolving charges (credit cards), installment loans (loans which have fixed monthly payments. auto loans are common examples of these); and mortgages.  On the other hand, any derogatory credit information, such as bankruptcy, foreclosure, child support delinquencies, collections, tax liens, judgments, or write offs (bad loans never collected the lender has given up on trying to get paid) are reported and taken into account.  So, a great payment history for your cell phone won’t necessarily help, but not paying your cell phone bill will hurt!  A mix of the types of credit is also factored into the score.  .