What is a FICO Score or Number?

By Vince Work · Jan 6, 2016 · Mortgage

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Image courtesy of Pixabay, Money Card Business Credit Card

This famous score goes back to the mid-1950s when two roommates sharing a San Francisco apartment came up with an idea.

What if you could use a computer to predict someone’s credit behavior?

The two roommates were Bill Fair and Earl Isaac. They both pitched in $400 a piece and started Fair, Isaac and Co., Inc. (now known as FICO) in that very apartment.

They wrote letters to 50 American lenders to see if they would be interested in their credit scoring algorithm. One lender accepted their offer and they were in business!

Today the words “FICO Score” has become nearly a household term – and synonymous with financing a home. Let’s discuss how the score works and why having a good FICO score doesn’t necessarily mean you’re going to be presented with the best loan for you.

Why Is Your FICO Score Important?

This score becomes particularly important when you’re applying for a home loan – or any loan for that matter. How good or bad your FICO score is will determine how much you’re going to end up paying for your loan – in terms of both upfront fees and total interest payments.

That’s right – there is a cost to getting a loan.

Not only do you have to pay it back, but also you will pay interest on the loan amount. On top of that, you might be charged additional fees depending on how your loan is constructed. You can substantially reduce the cost of a loan (assuming you’re dealing with a reputable lender – we’ll get into that more later) if you improve your credit score. That’s why it’s important to know what a FICO credit score is and how to improve your score.

Let let’s look at the spectrum of what constitutes a good and a bad credit score:

• Excellent (760 – 850) – You’re a superstar. You probably have a type A personality. You’re always organized and are always balancing your checkbook. However, this doesn’t mean you should stop paying attention to fees. Even people with the best credit can get fleeced with mortgage fees and interest.
• Very Good (700 – 759) – Pat yourself on the back! But there is room for some improvement. It’s probably worth a little more weekly attention to your finances. Read our tips on improving your credit coming up.
• Good (660 – 669) – It’s time to go from good to great. Start by paying your credit card balances on time and lower your overall debt as well.
• Fair (620 – 659) – Fair might sound safe, but it’s going to cost you. Time to get in credit shape. Treat it like exercise. Get disciplined and organized – your financial health will love you.
• Poor (580 – 619) – All is not lost. Start by getting organized. You might want to wait a good six months to a year before making a home purchase. Focus on paying bills and credit cards on time. You may even want to consider opening up a few more credit cards or lines of credit. Use them very rarely – making sure you’re always paying off the balances on time.
• Very Poor (500 – 579) – You’re not alone. Perhaps you’ve just come out of college and have a lot of debt, haven’t been paying your credit card(s) on time. Don’t worry, you can always improve. However, we would strongly recommend holding off on purchasing a home until you can improve your credit score and maintain it.

Let’s Look At How The FICO Score is Broken Down

Your FICO score is calculated based on five areas of your personal credit history and behavior. We made this handy little pie chart to visually show you what you need to be aware of:

The FICO score can be broken down into five factors. We’ve ordered them by most important factors first – that is, the factors that carry the most weight in determining your credit score:

• Payment History (35%) – This is the most obvious factor. Have you been good at paying bills and credit card statements on time? If you’re not the best at making payments on time, then this tardy behavior will certainly do the most damage to your FICO score.
• Debt Burden (30%) – This consists of how many credit accounts you have open and how much you owe on each one. If your debt burden is high, creditors assume the likelihood of you paying back any new loans is more unlikely (whether it’s on time or simply defaulting).
• Length of Credit History (15%) – Obviously, a great way of measuring your credit is by how long you’ve actually had credit. If you’re just out of college and have only had a credit card for one year (no mortgages or other lines of credit), then obviously there isn’t much to measure your credit worthiness by.
• Types of Credit (10%) – Credit cards, mortgages, revolving credit, payment installments. The more types of credit that you’ve had a history of using will help your FICO score out a bit.
• Recent Searches for Credit (10%) – If you've been shopping for a car, mortgage or other big purchases (where you need financing), then credit searches have been done under your name. If you’re planning on getting a mortgage soon, you should probably put off shopping for other large ticket items until your loan has been approved.

Let’s Look At The Price Of Improving Your Score

As we said before, there is a cost to getting a mortgage or a loan. And one of the biggest factors is your FICO credit score.

For every FICO point that you can improve on, the cheaper your loan will be when it comes to fees and interest. But remember! Just because you have improved your credit score doesn’t mean you’re going to get the deal of the century.

Getting a loan is still a business transaction and lenders are in business because of fees and interest. It will be up to you to do your homework while you shop. That’s actually one of the main advantages of using BeSmartee when it’s time for you to shop for a home loan. Our marketplace allows you to see all the fees and interest upfront before you begin the loan application process. You don’t have to ding your credit score before applying for a loan!

But let’s get back to the nuts and bolts of the FICO score. Below are a few graphs that show how much your interest rate can fluctuate based on your credit score:

click here to see the full sized version

The general trend in the graphs above is that the better your credit score, the lower the overall costs will be when it comes to getting your home loan. But there are two very important things to remember:

1. Lower rates can be misleading. Anyone can get a low rate if they are willing to pay for it. Meaning, if you’re willing to pay higher fees upfront, your interest rate can be lowered by the lender. Additionally, people with great credit aren’t always shown all the loans available in the lender’s inventory.
2. High LTV (loan-to-value) borrowers can get lower rates than people who can afford large down payments. This is thanks to FHA (Federal Housing Administration) insured loans. Depending on if you qualify, you can get a more affordable rate with a high LTV ratio.

Remember, Lenders Are In Business To Make Money

The person doing your home loan may have a financial incentive to steer you towards a loan that isn’t optimal for you. The loan they suggest may work for you financially and you may think that you don’t have any other loan options.

The truth is there is a secondary market where your home loan will most likely get sold on. Usually, the higher the interest rate you’ve signed up for, the more valuable your loan is on that market.

That’s why a lender might try to sell you on a home loan that appears affordable, but was actually designed to be more profitable for their business. The deception comes in the form of omission: they will rarely show you all the home loans available for you to choose from.

You should be able to pick the home loan terms that work for you. The interest rate, fees, duration and variability should all be transparent before signing on the dotted line. And most importantly, every loan in the lender's inventory should be available for you to look over. Not just the ones that benefit the lender.

That’s the advantage of BeSmartee. You can see all our home loans and costs up front.

Conclusion

Improving Your FICO Score is always a good thing to do. But there is a second piece to this puzzle. You need to be able to see the complete picture when it comes to all the types of loans that are out there for you. So do your homework and please reach out to us (@besmartee) if you have any questions.

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