What is a FICO score?
A credit score is a numerical index which represents an
estimate of an individual's financial creditworthiness. It is based on a subset
of the information in an individual's credit report. Lenders, such as banks and
credit card companies, use credit scores to determine credit limits and interest
rates.
The best-known credit score in the United States is the FICO score calculated
using mathematical formulae developed by the Fair Isaac Corporation. The three
major American credit-report agencies (Equifax, Experian and Trans Union) all
use variations on this scoring formula under different names, the best-known of
which are the Beacon score and the Emperica score.
FICO scores and its variants are designed to measure the risk of default, by
taking into account various weighted factors:
35% punctuality of payment in the past
30% capacity used, i.e., ratio of current revolving debt (e.g. credit card
balances) to total available revolving credit (e.g. credit limits)
15% length of credit history
10% types of credits used (installment, revolving)
10% amounts of credits obtained in the recent past
The above percentages are approximate. Current income and employment history do
not influence the FICO score.
There are other special factors which can weigh on the FICO score. One is that
any monies owed because of a court judgement, tax lien, or similar carry an
extra negative penalty, especially when recent. Having above a certain number of
consumer finance company credit accounts also carries a negative weight (critics
say that this causes a vicious cycle, locking people into continuing to use
consumer finance companies). The number of recent credit checks also can weigh
down the score, although the credit agencies allow for credit checks made within
a certain window of time to not aggregate, so as to allow the consumer to shop
around.
FICO scores range from about 300 to 850 and exhibit a left-skewed distribution
with a median around 725. A score above 720 is considered to be "good credit,"
and a score below 600 is considered to be poor.
In September 2004, a Texas utility company began setting individualized
electricity prices based on credit score.
As a result of the FACT Act (Fair and Accurate Credit Transactions Act), free
reports will be phased in during a nine-month period, rolling from the West
Coast to the East beginning December 1, 2004. Beginning September 1, 2005, free
reports will be accessible to all Americans, regardless of where they live.
Recently, some of the agencies which generate credit scores have also been
generating insurance scores, which insurance companies then use to rate the
quality of potential customers.
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