Don't Let Bad Credit Hold You Back!

How FICO Credit Scores Work

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Published: October 14, 2010

Credit scores seem shrouded in mystery: The agencies that collect the data and create the credit scores jealously guard their systems. Nevertheless, you can manage and even improve your FICO credit score—the best-known credit score—by understanding the basics.

How are FICO credit scores computed?

FICO uses five broad categories to calculate credit scores, and each category is weighted accordingly:

Why are there three FICO credit scores?

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:

• Each agency may have information one or both of the others don’t have. For example, a collection agency may have reported a bad debt to only one of them.

• Errors that occur just in one agency’s data may affect that agency’s results, but not the results from the other two.

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, they’re usually referring to the FICO scores.

Why can a credit check by itself reduce a FICO credit score?

FICO’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 purpose—such as when you’re shopping for a HELOC—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.

How long does major negative information stay on my credit report?

Generally, the impact of adverse information on a FICO score lessens over time.

How does loan modification affect my FICO credit score?

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 hadn’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.

Do reductions in credit card or HELOC limits affect my credit score?

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, you’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.

Do lenders have to tell me if they're basing a quote on my bad credit score?

New regulations taking effect in 2011 require lenders to tell you if they’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 rate—you were penalized without knowing it.

Starting in January, you’ll be forewarned. 

Then if your credit score is lower than you expected, you can investigate it—maybe it’s just an outdated report or a simple mix-up. At least you’ll know the deal before signing on the dotted line.

How to Get Your Credit Info

But don’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 isn’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 don’t include your FICO scores.

To get your score for free, you can check your credit card or auto loan statement. Some credit card companies provide the score in your monthly bill or in your online account. A non-profit housing counselor may also be able to get your score free of charge.

Some financial fitness sites like CreditKarma.com and WalletHub offer free reports, but you have to open an account. WalletHub, for instance, asks for some personal info so that the system can find your credit score. 

Finally, you can buy a credit score from the credit reporting companies or from myfico.com.

I personally recommend getting your free credit score report through Experian.com but it solely up to you and which ever website works for you the best.