What is a credit score?
When someone wants to borrow money, the lender checks the person's credit score. A credit score is a number that predicts the likelihood that a borrower will be able to repay the loan as agreed. Credit-reporting agencies are businesses that collect information about consumers' loan and bill payment histories. Credit agencies keep these records and, upon request, provide information to creditors in the form of a credit report. When a creditor requests a borrower's credit report, a credit score can be generated based on the information in the credit report. This score can also be purchased by lenders. Credit scores are one of the factors used by lenders to determine not only the amount of credit (if any) to extend to a borrower, but also the terms of the loan, e.g., the interest rate charged.
What are FICO scores?
FICO scores are the most widely used credit scores. FICO stands for Fair Isaac Corp., the company that developed the FICO scores system of evaluation. Fair Isaac develops scores based on the information that is provided by three major credit-reporting agencies: TransUnion, Equifax and Experian. Fair Isaac sells the scores to the credit-reporting agencies. Lenders buy FICO scores from one or all three of the major credit-reporting agencies. FICO scores vary, but generally the scores are between 500 and 850. FICO scores between 700 and 850 indicate that a borrower is very likely to repay loans and other debts. FICO scores lower than 600 indicate that a borrower may not be a good credit risk.
How are FICO scores determined?
FICO scores are determined using an equation that evaluates information from a consumer's credit report and that compares the results to the result of many other consumers' credit reports over time. The information from a credit report that is used to determine a FICO score can be grouped into five categories: payment history, amounts owed, length of credit history, new credit and types of credit used.
Does a high FICO score guarantee that a consumer will get a loan?
No score guarantees that a consumer will get a loan. A score is one of the factors in a lender's credit decision. Although FICO scores are important to lenders, every lender has its own strategy for lending, including the level of risk it finds agreeable for a given credit record. There is no single "cutoff score" used by all lenders.
How do borrowers get a better FICO score?
There is no quick fix. Raising a FICO score takes time. Types of credit in use, payment histories, amounts owed, length of credit histories and new credit are all factors in creating a consumer's FICO score. The best way for a consumer to ensure a good FICO score is to manage his or her credit responsibly over time.
The content for Q & A was compiled by Billy Britt, economic education specialist at the St. Louis Fed's Little Rock Branch, and was largely adapted from Fair Isaac Corp.'s "Understanding Your FICO Score." To learn more about credit scoring, visit Fair Isaac Corp.'s web site www.myfico.com/crediteducation. For a free credit report, visit www.federalreserveconsumerhelp.gov and click on the "Credit Report" tab.