Published: October 14, 2010
Buying a house, refinancing it, getting a loan, getting a jobâ€”theyâ€™re all dependent on your FICO credit score. It pays to learn how itâ€™s calculated.
FICO uses five broad categories to calculate credit scores, and each category is weighted accordingly:
|Length of credit history||15%|
|Types of credit in use (is it a â€œhealthyâ€ mix?)||10%|
There are three main bureaus that collect data on your credit history: Equifax, Experian, and TransUnion. FICO takes data from each credit bureau and runs it through its system. This leads to three different FICO credit scores because:
And to make it even more complex, many lenders augment their credit decisions by adding particular criteria they want to consider.
Also, although FICO is the best-known credit score, there are many others. Some lenders generate their own credit scores using data from the same three credit bureaus. Experian, in fact, has developed its own scoring system separate from FICO.
However, FICO remains the most common; when big lenders refer to your credit scores, theyâ€™re usually referring to the FICO scores.
FICOâ€™s research shows that more credit shopping, resulting in more inquiries, correlates with a higher risk of future default. However, multiple queries in a short period for one purposeâ€”such as when youâ€™re shopping for a HELOCâ€”would count as only one inquiry.
The FICO score ignores any mortgage, student loan, or auto loan inquiries made within the previous 30 days. The system limits itself to inquiries made in the 11 months before that, and reduces similar inquires within any 45-day window to a single inquiry. For example, if you approach five banks over two weeks on a HELOC, it will only count as one inquiry.
The inquiry formulas can get rather complex; the FICO site has more details.
Generally, the impact of adverse information on a FICO score lessens over time.
|Foreclosures||7 years, with rebound beginning in as little as 2 years.|
|Deeds in lieu and short sales||7 yearsâ€”they usually appear on credit reports as foreclosures.|
|Late payments||7 years. It doesnâ€™t matter what the late payments are for. Recent late payments hit your credit score harder than older ones, and the amount and frequency of the late payments are also factors.|
|Bankruptcies||7 years (10 years for â€œfull discharge of debtâ€â€”i.e., if youâ€™re absolved of your full debt, the bankruptcy stays on your credit report for 10 years). Because they often involve more than one account, bankruptcies generally have a greater negative impact on your credit score compared with a foreclosure, short sale, or deed in lieu.|
Until November 2009, if you were in a loan modification program, your credit report likely notes that you have made only a partial payment. This significantly lowered your FICO score.
However, in modifications made since November 2009, the credit reporting system was changed to reduce the credit score hit. But as of October 2010 FICO hadnâ€™t completely bought into this system and may at some point decide that everyone in a loan modification program, whether under new or old rules, deserves a significantly lower score.
For now, your best bet is to obtain your free credit reports, as noted later in this article, and see how your particular situation was reported and handled.
The impact will be unique for each consumer. The FICO formula considers many aspects of your balances and behaviors, including whether you have a high percentage of available credit at the time the report was pulled.
For example, if you have high debt and use a substantial proportion of your available credit, youâ€™re at a greater risk. Opening a new credit card to increase available credit, after another card was reduced, may backfire and reduce your credit score.
New regulations taking effect in 2011 require lenders to tell you if theyâ€™re giving you a particularly high interest rate or other less favorable loan term than other borrowers who qualify for the best deals. In the past, the lenders may not have told you that you were getting an especially high rateâ€”you were penalized without knowing it.
Starting in January, youâ€™ll be forewarned.
Then if your credit score is lower than you expected, you can investigate itâ€”maybe itâ€™s just an outdated report or a simple mix-up. At least youâ€™ll know the deal before signing on the dotted line.
But donâ€™t wait until you apply for a loan to discover your credit is a mess. By law, you can get a free report from each agency once a year at Annualcreditreport.com. (And no, this isnâ€™t the company advertising with the slacker band on TV.) This is the only site authorized by the Federal Trade Commission to provide free reports.
However, these reports donâ€™t include your FICO scores. You can purchase TransUnion and Equifax FICO scores from MyFico.com for $15.95 each. (Experian continues to provide a FICO score to lenders but no longer sells its score on a retail basis.)Â Some consumers will qualify for free FICO scores starting in mid-2011 or early 2012.