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A credit score is a three digit number assigned to each consumer by FICO based on credit data collected by credit reporting agencies. In the 1950’s Fair Isaac Co. was started by two business partners specializing in predictive analytics. Bill Fair and Earl Isaac (Fair Isaac Co.) created a system to assign a three-digit number to help lenders, insurance companies, and renters determine if a customer is a worthy risk to loan, insure, or rent to. However, it was not until 1991 that the three major credit reporting bureaus Experian, Equifax, and TransUnion saw the value in this scoring system and began purchasing credit information from FICO. The FICO score became the credit score of choice by the mid-1990’s. Ninety percent of the credit scores purchased by lenders come from FICO. The company Fair Isaac Co. officially changed its brand name to FICO in 2009. Who And What Determines Credit Scores?FICO collects credit data on billions of consumers. This data comes from the three major credit reporting agencies Equifax, Transunion, and Experian. Each time a consumer takes a loan, opens a revolving credit account, enters a rental agreement, or obtains an insurance policy, data regarding payment history, defaults, account balances, types of accounts, address history, work history, judgments, criminal history, and bankruptcy are collected. Much of that information is used to calculate the consumer’s credit score. FICO uses a formula that considers payment history, amount of debt, length of credit history, credit mix, and new credit inquiries. Each of these categories is given a percentage of importance.
Payment HistoryWhether or not a consumer pays their monthly payments on time is given the largest amount of weight in the formula. Making timely payments each month will improve your score. Paying off a loan early will not have a noticeable impact on your credit score. Amount of DebtThe second most important factor is how much debt a consumer has compared to how much credit they have available. This is also known as credit utilization. For example, if a consumer has three credit cards and each card has a credit limit of $1,000, $5,000, and $500 respectively, the total credit available is $6,500. Let’s assume that the card with a $1,000 limit has a balance of $500, the card with a $5,000 limit has a balance of $1,000 and the card with a $500 limit has a zero balance. The total amount of credit utilized is $1,500. Divide the balance of credit utilized by the total credit available; this equals approximately 23%. The consumer is utilizing 23% of their available credit. Length of Credit HistoryCredit history is given the third highest weight in the credit score formula. The longer credit history a consumer has will positively impact their credit score. In other words, the longer a credit account is open and active the more weight that account will have on a credit score. This is a challenging aspect for young people who are just starting to establish their credit history. Below are some tips on how teens can build their credit. Type of Credit or Credit MixThis category takes into consideration the type of credit accounts a consumer has. A good credit mix will include a mortgage, an auto loan, a few revolving credit accounts from MasterCard, Visa, or American Express, as well as large department stores such as Macy’s or Sears, and gas cards. New Credit InquiriesEach time a consumer seeks a loan approval, applies for a credit card, applies to rent a house or apartment, a hard inquiry can be made to that consumer’s credit report. Some banks require a credit check in order to open certain bank accounts. The more inquiries there are will have a negative impact on a credit score. Consumers should be aware of credit inquiries and the impact it could have on their credit score. Note: There are also soft inquires that might be done by potential employers, landlords, insurance companies, or companies who provide credit monitoring services. These inquiries are done to gage if a consumer is a responsible individual. These soft inquiries do not do impact credit scores. They may, however appear on a credit report. Tips to Help Teens Build CreditThere are a few things that can be done to help teens build credit. Opening a checking or savings account is one way. If they are over the age of 18, they can open a secured credit card. A secured credit card means the borrower makes a deposit on the card. The deposit amount usually determines the credit limit. Essentially, the card holder is borrowing their own money, but it’s also building a credit history as the card is used and the debt is repaid. Another option is for the teen to be an authorized user on someone else’s credit card account. A gas card is an excellent card for this purpose. There is minimal risk of overspending on a gas card. Lastly, a parent could put a household bill in the teen’s name. The cell phone bill would be one example. It is important to note that as a teen is building their credit, they also need to be taught how to manage their debt, the importance of monitoring their credit history, and the difference between a debit card and a credit card. |
