FICO scores are used by approximately 90% of lenders when determining the credit-worthiness of their applicants. It is by far the most respected type of credit score around; many advise against relying on non-FICO scores, which have been coined as FAKO scores.
In 2014 alone, there were around 11 billion FICO scores sold. The next closest figure comes from the VantageScore, which was sold to the tune of approximately 1 billion scores. While the VantageScore rating has grown immensely in popularity in recent years, there’s no doubt that your FICO score is still more important (and by far).
But, do not go into all this credit gibberish with an empty mind; it’s important to know how FICO scores work and how they impact you, so we will help you understand that!
Let’s get started …
What Does FICO Stand For?
FICO is an acronym for Fair Isaac Corporation. The business founded in 1956, when Earl Isaac (mathematician) and William Fair (engineer) ventured to create ‘borrower ratings’ for lenders. They started pitching their credit scoring system just two years later; by 1989, they established the first official FICO score rating algorithm.
The FICO system is used to evaluate a borrower’s credit-worthiness. It’s compatible with the three major credit bureau — Equifax, Experian and TransUnion — and currently serves as a rating system for borrowers in the United States, Canada, and Mexico.
Some quick facts about FICO’s rating system:
- Most scores range from 350 to 850 points.
- Equifax, Experian and TransUnion each offer their own FICO rating.
- While scores can vary by the information on your file, they use the same formula.
- In 2014 alone, close to 11 billion FICO scores were pulled.
Why is Your FICO Score So Important?
At least 9 times out of 10, you can ‘bank on it’ that your new lender will pull your FICO score to qualify you. It does not matter whether it’s for a credit card, mortgage, or a new car loan.
There are different types of FICO scores that exist (ex. FICO Auto Score), which make it easier to evaluate credit-worthiness by financing type. The platform was many years in the making, and it has certainly stood the test of time.
Lenders put serious value into these ratings, which is easy enough to prove considering the nearly 11 billion FICO scores pulled in 2014 alone.
Here’s Why You Should Care About Your FICO Score
Your FICO score can make a huge difference in the amount of interest you end up paying to a lender.
Buying a home?
With a FICO score ranging from 620 to 639, you can expect to pay approximately $93 more a month towards your mortgage. Over the course of 30 years, your fixed-rate home loan could cost $33,627 less if your score was between 760 and 850 instead.
You can still qualify for home financing — even with a poor credit score, as FHA home loans can help. But going that route is also disastrous, considering the interest rates are no better and there are premiums tacked onto your payments under FHA’s financing terms.
We covered your credit score’s impact on your mortgage rates and total cost before; you can find more information about this in our ‘What Credit Score is Needed to Buy a House?‘ post.
Buying a car?
If you have a FICO score ranging from 500 to 589, you can expect to pay around $591 a month for a 60-month new car loan. You will also face $10,467 in total interest payments. This is substantially more than what someone with good credit can expect to pay; a FICO score between 720 and 850 for the same loan will cost $139 per month less. In the end, the borrower with great credit will save around $8,326 in interest premiums.
Even worse, your insurance costs will be higher — it’s a proven fact that auto insurance providers consider their policyholders’ credit scores when calculating their coverage costs. This is not a good situation to be in, which is why we suggest you first establish a good FICO score and then apply.
Which FICO Scores Do Lenders Use?
There are over 50 different FICO scores that exist, which means there is no one-dimensional answer to this question.
Before you get confused, remember this: the FICO score established in 1989 is the, “base FICO score,” which now has many newer versions — such as, FICO Score 4 and FICO Score 9.
Meanwhile, there are other rating algorithms that FICO offers for different borrowing situations. The perfect example is FICO Auto Score — which is it’s own “base FICO score” in a sense, as FICO Auto Score 2, FICO Auto Score 3, and any newer versions are just updates to the base FICO Auto Score.
Aside from the many FICO scores, there are also countless FAKO scores that exist. These are alternative rating methods that are generally not used by lenders in any frequency. Although, the VantageScore rating system is pretty popular and over one billion of those scores were pulled in 2014 alone.
To generalize for simplicity purposes, here are the most-used score types:
Buying or refinancing a home?
Most mortgage brokers use the standard FICO score algorithm when determining a potential borrower’s credit-worthiness. As a buyer, you should focus on your base FICO score or any of its’ updated versions. At this time, the easiest to access version of the base FICO score is FICO Score 8, which is sold under myFICO.
Buying a new car?
Most car loan providers will evaluate your credit-worthiness based on your FICO Auto Score. This scoring algorithm was derived from the basic scoring system, but it considers other variables too. The point was to make a score that truthfully informs auto lenders on what they can expect from a prospective borrower. As FICO finely grooms their approach towards rating auto borrowers, new versions of FICO Auto Score get introduced and used by lenders.
Applying for a new credit card?
Many credit card companies will use one of the base FICO score versions to determine the credit-worthiness of potential cardholders. However, the FICO Bankcard Score is also often used by credit card issuers. But, it really just boils down to the particular card you apply to get. If you go for a retail credit card, your base FICO score is more likely to get used.
Applying for a personal loan?
If you enter the bank in hopes of getting a personal loan, chances are they will look at your base FICO score or a slightly newer version. Financial institutions do not like to change the score they use all the time; however, some will flex and pull the VantageScore 3.0 rating instead. Although, this is more likely when dealing with newer borrowers that have decent income.
Note: VantageScore is a type of FAKO score (by definition), but it gets used frequently so you should educate yourself on what’s different between each of the score types.
What’s the Difference Between FICO, FAKO and VantageScore?
FICO has proven the test of time, and it’s used by the vast majority of lenders. FAKO gives borrowers a way to see how their credit score is progressing, but it does little when most lenders pull a completely different score. VantageScore is the exception — not only is it used by around 10% of lenders, but it actually serves a purpose.
See, VantageScore works a lot like FICO ratings do and for good reason — did you know it was originally created by the three major credit bureaus? This particular rating approach is quite appealing to both borrowers and lenders, because it does not discriminate as much.
Take a look below at four key points that make the VantageScore rating formula appealing to both borrowers and lenders!
- You need less on your credit report to get rated, so you can start building credit faster. FICO wants half a year with an account reported before you get a score, but VantageScore calculates after a month.
- Late payments on mortgages hurt more than on credit cards, yet FICO treats late payments the same; your first missed payment will not be as damaging under VantageScore’s rating formula.
- You have 14 days to apply for credit cards without getting hit with a ton of hard inquiries, while FICO only offers this on car, home and student loan inquiries.
- With the latest VantageScore formula, debt ‘in collections’ does not matter so much — while FICO Score 8 only devalues the smaller ($100 or less) debts that are in collections.
With that said, you still want to focus the most on your FICO score — after all, it’s what the bulk of lenders still use and will likely continue to years for many years to come.
How is Your FICO Score Calculated?
Forget all the deviations, and just look at the base FICO score up to it’s most recent version. You will find that the formula used to calculate these scores is much of the same.
The main commonality would be the sections that impact your credit score calculation, and their strength.
Here’s the breakdown …
|Category||Score Impact||Factors Considered|
|Payment History||35%||Length of payment history, frequency of missed payments, etc.|
|Amounts Owed||30%||Outstanding debts among all accounts, amount of available credit tied up, etc.|
|Length of Credit History||15%||How old your accounts are, the average age of accounts, etc.|
|Credit Mix||10%||How many accounts and how much debt is held based on the type of financing, such as installment or revolving.|
|New Credit||10%||How many new hard inquiries, fresh accounts, and how much debt was recently taken on.|
This is the standard formula used by FICO to calculate scores, but the truth is there are many variables within that can influence your score. As the base FICO score releases with new versions of it, the deviations within each category grow larger. This is also why many banks stick with the older FICO scores, as otherwise it might be impossible for perfectly fine borrowers to refinance when needed.
With that said, FICO has stepped up to create new credit rating formulas. This initiative came as a result of the success with VantageScore; now, FICO has started rolling out a new score, which also targets those who have marginal credit history. With the new rating, different metrics will get used and thus, millions of consumers will have access to financing they previously could not get.
What’s a Good FICO Score?
The minimum and maximum points vary by FICO score type. This is how the base FICO score, and it’s updated versions, get classified by score range:
How Do You Find Out Your FICO Score?
By now, you probably know about AnnualCreditReport.com handing out your free annual credit reports from each of the bureaus. If you inspected your report, it should be obvious that your FICO score never gets mentioned. However, that could change — the ‘Fair Access to Credit Scores Act of 2013’ may eventually come to life.
Regardless, the wheels are already turning in the right direction — currently, around 100 million Americans qualify for free FICO scores through FICO’s ‘Open Access Program’.
Need your credit score now?
The fastest way would be to order your FICO score from myFICO.com — this is the consumer’s part of FICO’s business, not some fly-by-night scam site. However, you can expect to pay $19.95 for each of the scores — yes, it’s better to get your FICO score from all three bureaus and that would cost $59.85 in total.
“Can you get your FICO score for free?”
We went into detail on this subject recently — read our post: How to Get Your FICO Score for Free!
After extensive research, we came to the conclusion that there are no completely free ways you can obtain your FICO score. At best, you will qualify as a result of holding an account with a company that offers it as a feature or promotion.
Currently, more than a third of America’s adult population can get their FICO score for free through the FICO Score Open Access Program
How Often Should You Check Your FICO Score?
Your FICO score undergoes constant change, but the fluctuations directly result from changing to your credit report. These changes might not always get noticed — as in, it’s not necessarily new accounts and huge debt repayments that matter. For example, your FICO score could change day-to-day as a result of old missed payments aging, new credit improving your utilization ratio, and much more.
We recommend you monitor your FICO score at least once every three to four months. Many credit monitoring services (and even identity theft protection plans) offer tri-annual credit monitoring. This might seem like the obvious solution — but, wait, you must remember that most of these offer either a FAKO score or a VantageScore rating.
A slightly more expensive alternative, myFICO’s credit monitoring service, might make sense. This gives you your credit report and score every four months, as well as credit monitoring and identity theft prevention help. It also gives you access to the 19 most-used FICO scores, not just one. While the other features are not as impressive as what the competitors can offer, it is an excellent service for anyone focused on upping their credit score.
Conclusion: Your FICO Score Really Matters!
If a stranger asked for $200,000 out of your lifetime income, would you give them it?
Well then, why would you hand the same amount to a lender? Because, that’s effectively what you are doing by not caring about your credit rating. In fact, it’s been proven that the additional fees and interest for a poor credit borrower (versus an excellent borrower) can run far more than $200,000 over a lifetime.
And the clock is ticking, so all you can do is work towards a better tomorrow. Even if you just build a ‘generally respectable’ credit history, you will be able to achieve a ‘good’ credit rating. This alone can save you around $140,000 of the interest losses — so even if you only borrow when you need to, building your credit beforehand could save you a lot!