Understanding Fico Scores

UNDERSTANDING FICO SCORES

PROBLEM

This report is designed to inform the reader about FICO scores and make recommendations on ways to maintain a favorable score or improve an unfavorable score. This report will also answer these specific questions:

* What is a FICO score?

* How is the score determined?

* What effects does your score have on receiving credit?

* How do you find out what your score is?

* How can you improve your score?

BACKGROUND

In the lending industry, the FICO score is a tool used by financial institutions to asses a borrower's ability to pay a loan back on time. This assessment will determine what interest rate the borrower will pay and also whether or not they are granted the loan at all.

Most borrowers do not realize the importance of their score which is why this report was originated.

The research in this report was taken from a few different sources. The primary research was conducted by distributing a survey to the general public. The survey was designed to help us understand how much people actually know about their score. However, due to limited time and resources the survey was completed by only 20 people. The information provided by the survey was still useful despite the limitation on sample size. The secondary research was taken from websites, books, and training materials from the lending industry.

This report will contain three main sections. The first, Discussion of Findings, will give detailed answers to the first three main questions listed above. The second, Recommendations, will give specific strategies for improving your FICO Score. The third, Conclusions, will provide a summary of the information given throughout the report.

1

DISCUSSION OF FINDINGS

The research that we have conducted has revealed a wealth of information about FICO scores. This information has been organized into the following sections: (a) Origin of FICO Scores, (b) Structure of FICO Scores, and (c) Impact of FICO Scores.

Origin of FICO Scores

The term FICO is derived from the company that invented the mathematical equation for determining the score, Fair Isaac Corporation. Fair Isaac Describes their company as:

The leading provider of decision management solutions powered by advanced analytics. Fair Isaac solutions make mission critical business decisions that are more precise, consistent and agile. Thousands of companies in more than 60 countries use Fair Isaac technology to acquire customers more efficiently, increase customer value and retention, reduce fraud and credit losses, lower operating costs and enter new markets more profitably (Fair Isaac 1).

Fair Isaac designed the FICO score to help financial institutions determine the credit worthiness of a borrower. Today the FICO score is the most widely used credit scoring model in the United States. The credit score is derived from information contained in the borrowers credit report. Credit reports are put together and maintained by credit reporting agencies. The three major agencies in the U.S. are Experian, Equifax, and Trans Union. "Each of these companies has developed their own versions of the FICO score model and given these scores different trademark names: Beacon at Equifax, Empirica at Trans Union, and Fair Isaac Risk Score at Experian. These versions may differ significantly from the official FICO score" (Wikipedia 1).

Structure of FICO Scores

Like any mathematical equation a FICO score is calculated using variable factors. This section will explain these factors. Also this section will cover the range of a FICO score and what is considered a good, average, and poor score.

Range

A FICO score can range between 300-850 points. According to myFICO.com the median score in the U.S. is 723. This means that a high percentage of the U.S. population has a credit score above 700. Generally a score of 700 or above is considered good credit. Any score below 600 would indicate poor credit.

2

Score Factors

The most important part of understanding FICO scores is knowing the factors that make up the score. Some factors affect the score more than others. The five major categories that make up a FICO score are as follows: payment history, amounts owed, length of credit history, types of credit used, and new credit. The following pie chart illustrates these categories and their impact on the score:

The explanation of these categories is as follows:

* Payment History: The highest percentage of the score is determined by your payment history. This category includes several different factors from your credit report including: delinquencies, Public Records (bankruptcy, judgments, liens, etc.) collection accounts, charged off loans, and settled accounts. A current delinquency will lower the score more than a past delinquency. The severity of a past or present delinquency will affect the score differently as well. Late payments are measured by 30 day increments. A payment that was 30 days late will affect a score less than a payment that was 90 days late. Also the amount of time since a late payment was made determines the amount of points lost because of that late payment. A late payment made two months ago will lower the score more than a late payment made two years ago. If a late payment is made only time will correct it, so make sure all payments are on time to keep a high credit score.

* Amounts Owed: The second highest percentage of the score, this category is also referred to as capacity. This category looks at the proportion of balances to the total limits available on revolving credit lines (credit cards, lines of credit, etc.). So if you take the total of all balances and divide that by the total of all limits you will get a percentage that represents capacity. The proportion of balance owed to original loan balance on installment loans (autos, mortgages, personal, etc) is also