Who is FICO and Why Do They Score You?

To many, FICO is similar to the Wizard of Oz.  The mystery of how they operate is huge and so is the result of their scoring your credit worthiness.

Who is FICO?

In 1956, Bill Fair and Earl Isaac founded a software company in San Jose, California.  They developed a process for measuring consumer credit risk.  The score ranges from 300 to 850 based on the credit behavior of the person.  In 1989, the company made its first general purpose scoring system available for lenders.  In 2013 alone, mortgage lenders purchased more than 10 billion FICO scores with credit reports.

Why Do They Score You?

Prior to this scoring system, lenders were expected to carefully analyze each mortgage loan application based on the known merits of the borrower.  It was much easier for borrowers to hide derogatory information.  The process was also dependent on the highly developed skills of loan officers and underwriters to weight such things as being late on rent and not paying a small medical bill.  FICO scoring is still an inexact science, but it takes much of the human error out of the equation.

Scoring Factors

Mortgage companies use your FICO score to determine both the amount of loan they will offer and also the interest rate they will charge.  In other words, the monthly payment (principal and interest) for your mortgage strongly depends on the level of your credit score.

Here is how the score breaks down:

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  35% is based on your payment history

  
  


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  30% looks at the amount of money you owe

  
  


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  15% compares the length of time you have had a credit history

  
  


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  10% brings your new credit into the picture

  
  


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  10% gives weight to the types of credit you currently use

  
  

The average FICO score in 2014 is 689 according to MyFICO.com.  However, what you may not realize is the difference between a 620 credit score and 760 score can translate into more than a full percentage point in interest.  This one percent difference amounts to many 10s of thousands of dollars over the life of your loan.

What You Can Do?

With increasing home prices in our area, the general rule is you should purchase sooner rather than later.  However, a few things you should keep in mind before you go house shopping:

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  Know what is on your credit report.  Errors are common in reporting credit.  From someone else’s poor behavior showing up on your report – to – a long standing good credit history being missing…it all can hurt you.

  
  


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  Protest and correct any errors.  There are companies who specialize in cleaning up credit reports, but you may be able to do it yourself.  Investigate what needs to be done and hire a professional to help you rather than paying excessive mortgage fees throughout the life of your loan.

  
  


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  Be pre-approved as early as possible.  Don’t assume paying off a car or eliminating a furniture debt will improve your FICO standing.  Ask for a pre-approval early and also ask if you can improve your score by making a few changes.

  
  


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  DO NOT apply for credit elsewhere.  Many home buyers are disappointed when a recent car or furniture purchase hurts their credit.  The rule is: do not buy anything on credit until  your new home purchase is closed.  Period.