Definition

A FICO score is a credit scoring model that is widely used by lenders to assess the creditworthiness of individuals applying for credit, such as loans, credit cards, mortgages, and other types of financing. 

What is a FICO score?

The FICO score is based on information in individuals’ credit reports and provides a numerical representation of their credit risk. It was developed as a standardized credit scoring model to help lenders evaluate the credit risk of consumers more objectively and consistently.

FICO scores are calculated based on information from individuals’ credit reports, which are maintained by the three major credit bureaus in the United States. The key components used to calculate a FICO score include:

• Payment history (35%): This assesses individuals’ track record of making on-time payments on credit accounts.
• Amounts owed (30%): This evaluates the total amount of outstanding debt relative to available credit limits across different types of credit accounts.
• Length of credit history (15%): This considers the length of time individuals have been using credit.
• New credit (10%): This looks at individuals’ recent credit inquiries and newly opened credit accounts, which may indicate increased credit risk.
• Credit mix (10%): This assesses the variety of credit accounts individuals have.

The FICO scores range from 300 to 850, with higher scores indicating lower credit risk and lower scores indicating higher credit risk. The distribution of FICO scores among consumers typically follows a bell-shaped curve, with the majority of individuals falling within the middle range of scores. Higher FICO scores are generally associated with lower interest rates, larger credit limits, and more favorable terms on loans and credit cards.

Example of a FICO score

John recently applied for a car loan at a local bank. As part of the loan application process, the bank pulled John’s credit report and calculated his FICO score to assess his creditworthiness.

Upon reviewing John’s credit report and FICO score, the bank found that John had a FICO score of 720. This score falls within the “good” credit range, indicating that John has a relatively low credit risk.

Based on John’s FICO score of 720, the bank approved his car loan application and offered him a competitive interest rate on the loan. John was pleased with the outcome and proceeded to purchase the car he had been eyeing.