Over time, people have created increasingly complex forms of money – coins, paper money, checks, and credit cards – which have required more advanced tools for measurement and usage. Nowadays, a person’s “Credit Score” has become an important form of identification. In living rooms, Wall Street board rooms, and banking inner circles, the FICO Score has become a measurement that can determine the success or failure of a customer in receiving credit, insurance, or even employment. But what exactly is a “Credit Score?”

Origin of the Credit Score

In 1970, Engineer Bill Fair and Mathematician Earl Isaac created a complicated formula that would measure the credit risk of a debtor (the likelihood that a debtor would make timely payments and repay a loan). These two entrepreneurs created the Fair and Isaacs Company (FICO); the FICO Credit Score has become the global standard for credit risk assessment.

Minimum for Credit Score

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According to Fair Isaacs, the minimum required for a FICO score to be created is for a customer to have one credit account with at least six months of history. Most banks, lending institutions, and credit card companies prefer three to four credit accounts with at least one year of history. Banks and financial institutions wanted to development a measurement by which they could determine a consumer’s creditworthiness without knowing the individual’s employment or income history.

Since the three primary credit bureaus – Experian, Equifax, and Transunion – don’t have the same access to your account information, the credit scores that they report might vary slightly. These credit scores are based on the FICO template.

Elements of the FICO Score Calculation

The goal of the credit score assessment is to consider your debt load, history in paying bills, and type of loans taken out in order to measure the health of your credit portfolio. The following five criteria are weighed to create the three-digit FICO score: 1) Payment history, 2) Credit use, 3) Credit history length, 4) Credit type, and 5) Recent searches. Each is weighted accordingly:

• 35% Payment History – Timeliness (punctuality) of payments
• 30% Credit Use – Ratio of current “revolving debt” to available credit limit
• 15% Credit History Length – Longer credit history is better
• 10% Credit Use Type – Mortgage, automobile, and revolving debt
• 10% Recent Searches for Credit – Housing, employment, or consumer finance loan.

The typical FICO score range is from 300 to 850 with the majority of scores from 650 to 799. The median score is 720; a good score is above 725. A higher score means that there is a greater likelihood that the debtor will repay a loan.

The Payment History section includes the following information:

- Account payment information on credit cards, automobiles, and mortgages
- Adverse public records (liens, bankruptcy, and collections)
- How long payments are past due
- Amount due on delinquent accounts
- How recent the delinquency, public records, or collection items are
- Number of past due items
- Number of accounts paid as agreed.

The Credit Use section includes the following information:

- Account limits
- Number of accounts with balances owed
- Ratio of credit lines used.

The Length of Credit History section includes the following information:

- When accounts were opened
- Last account activity.

The Types of Credit section includes the following information:

- Credit cards
- Retail
- Mortgage
- Installment
- Consumer finance.

The Recent Credit Searches section includes the following information:

- Recent credit inquiries (employment, insurance, and housing)
- Application for new credit
- Proportion of New Accounts to Total Accounts
- Re-establishment of positive credit history after problems.

Common Credit Score Terms

Consumer finance credit – Loans to individuals
Installment credit – Fixed number of payments (i.e. student loan, consumer loan, or mortgage)
Revolving credit – Borrower does not need to fully pay off every month.

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