June 9, 2017 Mallory 5Comment

A good credit score is like a clean bill of financial health, right? A well known advantage of a high credit score is the possible low interest rate one can score when taking out a large loan such as a car or home loan. The usual mantra goes something like this, “hey loan officer, our credit scores are high so our interest rates better be low!” The funny thing is most loan officers don’t actually see your credit score. They only see your FICO score.

 

Isn’t a credit score the same thing as a FICO score?

 

No, not entirely. A FICO score is the non-consumer version of a credit score. Almost everybody know that a credit score is the measure of how likely you are to pay back debt. A FICO score does the same thing but they go by a slightly different algorithm which I will break down below. Your FICO score tends to be slightly lower than your commercially available credit score.

Credit vs FICO

There are three different credit bureaus: Equifax, Experian and TransUnion. All three bureaus have slightly different algorithms for calculating your score. These scores are used when a person wants to make a large purchase or loan. Just because you saw one of your commercially available credit scores does not mean that you saw your actual FICO score. The FICO score is usually the only score your lender actually sees on paper. The rest of the three credit scores are slightly different, for consumers eyes only.

 

A FICO score is the lending industry’s gold standard and their only other competition is VantagePoint which is used just 10% of the time. The FICO score is considered the king in both domestic and international monetary matters.

 

If you are still confused what a FICO score is then I can summarize it in two sentences: it’s basically the grown up version of being graded. It’s the official transcript & SAT score you send off to colleges to prove you’re not a total screw up.

FICO Breakdown

A FICO score is not going to discriminate based on age, race, religion, gender, or bubble gum flavor. FICO will not be influenced by your location, your income or any legal position you are in. A FICO score is made up of only these 5 things:

35% payment history

This is the most important content of your FICO score. It is based on how trusted you are to repay money that has been borrowed.

  • Have you paid your bills on time? How often did you miss payments? How long were you late on those payments? Are there any red flags on your account such as bankruptcies, liens, and foreclosures?

30% credit utilization

This part is the funky part and I agree with Dave Ramsey that this is your “I <3 debt” score. It’s a business yeah? They want you to use your credit line because at the end of the day, you have to pay it back. It’s your relationship with debt that makes up 30% of this score.

  • How much does the debt you owe compare to your overall credit limit? How much mortgage and/or auto loan debt do you owe?

15% length of credit history

This is simply just how long you’ve had those lines of credit open. After you’ve pay off long term credit card debt, industry professionals typically advise you to keep the account open even if you feel tempted to close it. This is because of this 15% length of credit history to your FICO score. Credit is big business right? They want to keep you as a customer by keeping those lines of credit open so someday, you can return as a customer.

10% new debt

This is simply how many lines of credits have you recently opened. When lenders see a dramatic increase in new lines of debt, your FICO score is knocked down because you are now carrying more liabilities without a history on them.

10% mix of credit

What type of debt do you have (car loan, mortgage, construction loan etc.)

The Truth About Your FICO Score

There is a lot of misinformation out there regarding FICO scores. Many people believe your FICO score and your credit scores are a measure of wealth considering a good 35% chunk of your FICO score grade is made up of payment history. You need to have money in order to have a good payment history right?

Mmm.

Actually, only 35% of Americans do not carry a balance on their credit cards. This means the large majority of Americans do! When the economy goes down, credit card borrowing inches higher. When the economy goes up, the credit card borrowing inches higher anyway!

The majority of Americans have credit card debt. Paying back regularly scheduled debt is good for your FICO score. But if you do not pay back your balance you are essentially measuring your relationship with debt.

Any relationship with consumer debt is a bad relationship.

Now that you know what a FICO score really means, shake your head the next time someone shows off how high their FICO score is.

Side Note

Since there are specific guidelines to a FICO grade, it might not cover every financial situation perfectly accurately. For example: my husband and I are churners. ‘Churning’ is slang for a game consisting of opening credit cards for the rewards, getting those rewards and never carrying a balance on those cards ever again! 😉 Pretty simple in summary. Credit card companies want your business so they are willing to entice you in with the promise of redeemable points for flight miles and oh yes, cold hard cash, if you sign up for their card.

Quarterly, our credit score takes a hit once in awhile when we decide to open up a few new credit lines. It’s a great way to earn free money as long as you are keen on the bills and up to date with your financial life. But to an industry lender who is looking into our record, they might see and think we’re under financial stress since we just opened up X amount of new credit lines. This is under the assumption you wouldn’t need to open new lines of credit if you had money available. That is the trade off churners have to make. Fortunately this “new line of credit” is only 10% of your graded score. This is a fair tradeoff for churners like us.

 

About the Author: Lily

The Frugal Gene

[[ I’m Lily, I’m a millennial money blogger at The Frugal Gene. Me & my husband are the ultimate millennial super savers. We scrimp, save, and work our bums off to save over $100,000/year in the grandest pursuit of financial freedom. Hubby & I live our lives car-free and debt free. We moonlight as your coffee pouring hosts on AirBnB. It’s a total dance party @ thefrugalgene.com ]]

 

 

5 thoughts on “The Truth About Your FICO Score by Lily from The Frugal Gene

  1. My score is 830 and I’ve never run a balance on a credit card. I have no debts, even the house is paid for. I always pay cash for cars. Dave Ramsey says most people pay a lot to earn a high credit score, usually I agree, but in my case it cost me nothing.

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