|Notebook image from freedigitalphotos.net|
How is this different from a credit report? A credit report lists all of the components of a credit score (how much debt you have, how long you've had it, if you pay on time, etc.). The credit score consolidates this into one number using a semi-mysterious algorithm.
So why do you keep throwing out the term FICO score when it's just a credit score? The FICO score is sort of a brand name of credit scores, and it's the most commonly used. The name comes from the company's original name-- Fair, Issac and Company. Now it's been renamed to just "FICO."
The WHYSo this FICO score is kind of a big deal. "But I pay cash for everything," you say. "Why do I want a great credit score if I never plan on needing credit?" You may have a point if you plan on paying cash for your house too, but otherwise, I say get on the dang FICO score bandwagon.
It's one of those "big" things we like to talk about on our blog that can wipe out decades of scrimping at the grocery store if you screw it up. How big is it? Well, say you take out a $300,000 mortgage on a home with a FICO mortgage score* of 687 (the national average). Over the life of the loan, you'd pay about $243,000 of interest (you read that right). But if you Money Hip Mama-ed your score up to 800 or so, you'd pay closer to $218,000 in interest. That's a $25,000 difference. Big stuff. We used this calculator to run our numbers. It's pretty fun to play with if you're bored and into hypotheticals.
So by now you probably want to know how they come up with this all-important number. The actual equation they use to calculate it is top-secret, but we do know the basic inputs (all of which come from your credit report) and general weighting of importance.
|Remember how I said here Lisa and I kind of have a cake bond? Here's one I made for a roommate's bridal shower. Chocolate ganache is my go-to for the deliciousness factor.|
- Payment history (~35%): Do you make your credit card/car/mortgage, etc. payments on time?
- Amounts owed (~30%): This doesn't necessarily mean you need to have $0 balance on your credit card continually to get a high score-- what it does mean is that you know how to use debt without getting up to your eyeballs in it (maybe you should shoot for ankles or lower).
- Length of credit history (~15%): It takes time to build trust here too.
- Types of credit (~10%): You'll earn more "street cred" if you have different types of debt (think credit card + car loan) instead of just your cards from Gap, Banana Republic, and Target.
- New accounts (~10%): Going on a card-opening bonanza can hurt your score. Slow and steady does it.
That adds up to 100%, right?
Now that you're super intrigued about credit scores, next Thursday we'll talk about how to optimize and monitor them.
*There are different kinds of FICO scores-- generic, bankcard, mortgage, to name a few. But the general principles are the same, so we won't differentiate here.
Share-- How did you first learn about credit scores?