All About FICO Credit Scores from the FICO CEO
Mark Greene, chief executive of Fair, Isaac & Co., creator and proprietor of the FICO score provided this explanation of credit scores:
“The FICO score is a measure of a consumer’s financial health and creditworthiness,” Greene says. It’s simply a number, ranging from 300 to 850 — the higher the better. The average FICO score in the U.S. is about 700, and pretty much every bank in the country uses a FICO score when making lending decisions. But while the scores are important, they’re not the be all and end all.
“Scores are meant to be one of several things bankers use in doing what we call sound underwriting,” Greene says. Lenders should also be taking into account borrowers’ background references, their capacity to repay loans, and collateral.
FICO creates the score simply by feeding numbers into its formula: “It’s based on pure, statistical evidence, with no judgment or evaluation or emotion.” The main factors Fair, Isaac takes into consideration are:
- • How much total indebtedness a consumer has
- • How long they’ve had the debt. “Newer relationships are riskier than things you’ve been paying over a long period of time,” Greene says.
- • How much available credit is being used: “If you’re close to the edge on your credit cards, that’s a danger signal.”
- • The mix of an applicant’s credit portfolio — is it all credit cards (bad) or a mixture of credit cards, a mortgage, and a car loan.
Greene outlines three key ways through which people can improve their scores. First, pay your bills on time. Second, don’t get close to the edge: “Don’t use more credit than you really need.” And third, don’t apply for new credit unless you absolutely have to.
It may sound obvious, but the easiest way to avoid a sharp downgrade in your FICO score is to stay current on your mortgage and stay solvent. “One thing people should know is that a foreclosed home or personal bankruptcy is the most severe harm that you can do to your credit score,” Greene says. FICO scores can fall by as much as 150 points when borrowers walk away from mortgages or declare bankruptcy; it can take up to seven years to rehabilitate the rating.
Greene helps clear up what may be some misconceptions about the way credit scores are calculated. For example, is it true that every time you apply for a loan it hurts your score?
“It depends on the kind of product you’re shopping for,” says Greene. With car loans, for example, Fair, Isaac understands that people shop for rates. “If you apply for five different car loans within a couple of days, we understand that you’re looking to buy one car at the best rate. And there’s no adverse impact on your credit score.”
On the other hand, when people apply for five different credit cards in the space of a week, they’re usually seeking to open multiple accounts simultaneously. “In those situations we will take a few points off someone’s FICO score because we’re worried they’re sending a signal that they need too much credit.”
Is it also true that people who have little or no debt may find themselves with lower credit scores? That can be the case. “Warren Buffett used to say that he didn’t have a particularly high credit score,” says Greene.
Consumers can obtain their FICO score from the company at myFico.com. (Editor’s note: Greene says the report is free in the accompanying video but you must register to receive your FICO score and a payment is required.)
Greene also points to a just-launched website, scoreinfo.org, that helps people understand how credit scores factor in this new era of financial regulation. As of January 2011, you have the right to receive your score any time a lender makes certain kinds of decisions — e.g., if you’re denied credit or given credit on less than the most favorable terms a lender offers.
In the U.S. economy today, people may frequently find that a credit score is being used by companies to make decisions that have nothing to do with credit. Credit scores have become part of the application process for jobs, car insurance, and health insurance. Greene notes that the credit score can be useful in non-lending contexts: “People who are good with their finances frequently turn out to be good drivers.” But he reiterates that they were designed for a purely financial use.