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Vol. 17, No. 1

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What Makes Up Your Credit Score?

It’s that mysterious number that can make or break the deal on your mortgage and your car loan and even determine how good a package your cell phone company will offer you. So where did it all begin?

In 1956 Bill Fair, an engineer, and Earl Isaac, a mathematician, founded the Fair Isaac Corporation, which developed FICO scores, a measure of credit risk that is the most used credit scoring system in the world. FICO scores are used by all the three major consumer reporting agencies in the United States and Canada—Equifax, Experian, and Trans Union—and available to the public from all but Experian.

But what elements does the Fair Isaac Corporation use to create a credit score, which ranges from 300 to 850? One would think that bill payment performance would be the basis for a credit score; however, paying bills on time comprises only about one-third of the formula that determines a credit score. The remaining two-thirds of the formula can make or break a FICO score.

According to Fair Isaac, payment history counts for 35 percent of the FICO score; available credit used comprises 30 percent; length of credit history counts for 15 percent; types of credit used accounts for 10 percent; and new credit applications comprises 10 percent. While paying your bills on time is simple to understand, what about the rest?

Available credit. The percentage of available credit used is measured by looking at the total credit available to the card holder (based on all of the credit cards issued) compared to the amount of credit actually being used at the moment that the FICO score is computed. For example, if a card holder has $10,000 in available credit and used $5,000 worth of credit, the credit utilization percentage would be 50 percent. The lower the credit utilization percentage, the better the FICO score. There appears to be no advantage to paying off a credit card each month over carrying a revolving balance when determining the credit utilization percentage. Thus, one would be better off not carrying any balance and not making any charges surrounding a credit application event such as purchasing a new car or major appliance that is intended to be financed.

Credit history. The length of credit history pertains to the age of credit accounts. The older the credit account the better, providing that one is paying on time and not using more that 10-15 percent of the available credit. Closing older and less used credit accounts is not wise when it comes to maintaining a good FICO score.

Type of credit. Fair Isaac Corporation is looking for diverse credit usage currently and in the past to determine the type of credit used. A FICO score will improve if one has credit cards, retail cards, gas cards, auto loans, home loans, student loans, and personal loans, currently or in the past that meet the other FICO considerations. However, going for the six- or 12-months same-as-cash deals that many retailers offer can jeopardize a FICO score even if the account is paid in full without interest because retailers often place these credit deals with companies that finance high-risk credit consumers. Even if you pay the bill off on time, the terms and rates of these secondary companies raise a red flag to FICO scorers.

It appears that applying for any type of credit may harm a credit score. The Fair Isaac Corporation looks at the number of credit applications a consumer has made during the 12 months prior to the credit check. A credit application is considered any transaction that is subject to a credit check, and, unfortunately, today just about every consumer transaction can involve a credit check. Applying for an apartment lease, applying for a job, buying a cell phone, ordering utility service, purchasing automobile insurance, purchasing life insurance, obtaining a surety bond, and myriad other necessary consumer transactions may generate a credit check. Obviously, individuals who are using credit wisely should have no trouble getting credit even though there are several credit checks, but they will likely be disheartened to find out that their FICO scores are less that stellar because they were involved in several credit reporting transactions.

To obtain a credit score, go to www.myfico.com. (There is a fee.) For more information about Fair Isaac Corporation go online to www.fairisaac.com.

Michael P. Hurley is a partner in the law firm of Nelson, Sweet & Hurley, Painesville, OH. He is an active member of the ABA’s GPSolo Division, including past-chair of its Business and Financial Planning Committee. This article is adapted from one that appeared in the Ohio State Bar’s Solo, Small Firms, and General Practice News . Contact him at mikeh@mailbag.net.

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