On FICO Scores and Building, Repairing and Maximizing Credit scores

Credit scores are designed to measure default risk.  Understanding how the lending industry determines creditworthiness can accelerate building, rebuilding or maximizing borrowing ability and financial stability.

A credit report details residence, credit and payment activity for the previous seven to ten years.  A FICO (Fair Isaac Corporation) score is a mathematical measurement of the likelihood of debt repayment.  FICO (or ‘Beacon’) scores vary based on data from three main credit bureaus, Experian, Equifax, and TransUnion, depending on how each bureau analyzes data.

Higher scores indicate lower credit risk.  Mortgage scores are between 300 and 850, but most FICO bankcard and auto scores are between 250 and 900.   Generally, those with high FICO scores consistently pay bills on time, keep balances low on credit cards and other accounts and apply for new credit only as needed.

Collateral, Capital, Capacity and Character measure credit risk and determine credit scores;

1. Collateral:  The value of an asset which lenders can repossess in lieu of payment.

2. Capital:  Accessible financial wealth to repay debt including checking, savings accounts and equity in relatively liquid, 'sellable', available assets.

3. Capacity:  Ability to repay measured by income, banking and employment history.  Rising income and steady employment is better than higher debt and uneven work and earning histories.

4. Character:  A credit score and report review to predict trustworthiness.  Have both a savings account and pay bills with a checking account.  Have credit accounts and manage them responsibly.

FICO doesn't disclose exact credit score calculation formulas, but does disclose the following weightings:

1. Payment History = 35%;  Responsibly managing financial accounts and timely payments leads to higher scores.  Consumers without credit cards, checking and saving accounts tend to appear to be higher risk to lenders than those who've maintained assets, managed debt and dealt with the financial industry responsibly over time.  Making payments on time has the greatest effect on improving scores.  The longer bills are paid on time over time, the better the score.  

Delinquent payments negatively impact scores.  The presence of bankruptcy, liens, judgments, settlements, charge offs, repossessions, foreclosures and late payments harm scores.  

The impact of past problems fades as time passes and more recent better payment patterns appear, the higher scores should rise.  Paid off collection accounts usually stay on a report for seven years, but older problems count less than recent issues.  

Working with a retailer or business who may provide credit on a purchase regardless of credit standing can help.  Consider a secured credit card or a secured loan to repair damaged credit.  Most financial institutions will provide a credit card or a loan in exchange for a sum of money deposited with them until the loan is paid in full.  

2. Debt Burden = 30%;  A measure of a number of financial metrics; Debt to limit ratio, number of accounts with balances, amount owed across different types of accounts and amounts paid down on loans.  High outstanding debt relative to available credit can affect a report and score.

Rebuilding or increasing the ability to finance or refinance purchases with lower interest rates and payments begins with checking the data used to calculate reports.  Confirm amounts owed, interest rates charged and check for errors.  If a credit report correctly shows missed payments, get and stay current.  As long as a report is ordered from a credit agency or authorized organization, requesting credit reports won't affect scores.  Credit agencies are required to provide credit history information correctly, completely and confidentially.  Reports can be obtained without expense www.annualcreditreport.com.   Free credit reports can be reviewed three times per year if requests are alternated between www.transunion.com, www.equifax.com and www.experian.com

Apply for and open new credit accounts slowly, only as needed and responsibly pay them off.  If managing credit for a short time, don't open a lot of new accounts too rapidly.  Rapid account buildups by new credit users can be seen as risky to lenders.  New accounts lower average account age and has a larger effect on scores for those with little credit history.

As such a large part of a FICO score is determined by the ratio of credit used to credit available, one way to increase scores is to increase the credit limits on current credit card accounts.  The higher the credit limit on credit cards and revolving credit accounts, the lower the utilization ratio of total available credit.  Higher limits on existing credit lines can help a credit score.  Try to keep balances low relative to credit limits by staying at least 30% away from available limits.  When practical, pay off debt instead of moving it around.

Remove incorrect credit report information by disputing errors;  If a error is found, send requests for correction by certified mail with phone follow up to the reporting creditor and all three reporting agencies.  If a collection is paid or a debt is settled, ask the creditor to delete the credit report item, instead of a “paid collection” entry.  Document dates, phone numbers, times, names and titles of everyone spoken to etc...  Ask for written confirmation of corrections and a Universal Data Form (UDF), documents consumers and lenders can send to credit bureaus to update reports.  Also send confirmations and UDFs to all creditors, as interest rates on other accounts may have increased even if not related to erroneously reported entries.

3. Credit History = 15%;  Timely paying on credit card and installment loans raises credit scores. 

Pay bills on time by setting up payment reminders prioritizing paying down principal of the highest interest debt first while maintaining minimum payments on other accounts with lower rates.  Don't open unneeded credit cards to increase available credit.  For newer credit users, rapid account buildups can appear riskier to lenders.  Newer accounts usually lower average account age, which affects scores for consumers with little other credit history.  Lenders consider average age relative to the oldest accounts.  The older the average age of the total number of accounts, the better the score. Don't close unused credit cards or open unnecessary accounts to increase available credit, as doing so could lower credit scores.

4. Credit Type = 10%;  Financial institutions look for a positive history of managing different types of installment, revolving, consumer finance and mortgage accounts. 

5. Recent Credit Search History = 10%;  Too many recent 'hard' credit inquiries, when consumers apply for credit or a loan, especially if done in large numbers over too long of a time frame can hurt scores.  

Search for credit in a relatively short time frame.  Looking for mortgage, auto or student loans may cause multiple lenders to request reports for only one loan.  Credit Bureaus consider inquiries falling in a typical shopping period as just one inquiry.  FICO's model considers auto loan inquiries within two weeks as only one and will likely not meaningfully decrease scores.  Generally, most scoring systems ignore credit inquiries within thirty days while shopping and don’t consider multiple inquiries a negative after 12 months.

Have as much fun as soon as possible, with the least amount of risk for as long as you can.