The FICO Score system is the most relevant economic metric for anyone who wants to demonstrate their monetary stability. This score speaks for itself when you decide to buy a house, rent an apartment, or even get insurance at a reasonable price.
Understanding how this number is constructed is vital to understanding the complex financial system that awaits you. At CredHelper, we explain the five pillars that support your credit reputation.
What does the FICO Score represent, and why is it the industry standard?
Basically, the FICO Score represents the probability of risk existing in the application for a loan. In other words, it is a statistical model that analyzes the data from your credit reports to predict how likely it is that you will fall behind on a payment.
It analyzes the likelihood that a consumer will default on a debt within a 90-day period within the next two years. This score is determined by three digits ranging from 300 to 850. The higher the number, the lower the risk perceived by lenders upon your application.
It is the standard of the monetary sector and represents your level of discipline and your ability to organize finances. Also, talk about respect for debt contracts you’ve signed in the past.
While there are other ways to analyze this risk, this score is used by 90% of lenders in the country. It is taken into account for your credit approval decisions thanks to the technical confidence it provides.
5 factors that contribute to increasing your FICO score
It is key to understand that this model is not static or arbitrary. It’s based on information contained in your credit reports from 3 main bureaus, which are: Equifax, Experian, and, of course, TransUnion.
Its standard is built on the analysis of millions of real consumer profiles over decades.
- Payment history. It is proof that you keep your word on the agreed dates.
- Amounts owed. It represents your level of solvency and dependency.
- Age of the credit. Measuring how long you’ve been handling credit gives a clearer view of your behavior across different economic cycles.
- Credit mix. Evaluate whether you are able to handle many types of debt at the same time.
- New credit. You can review whether you are desperately or in a controlled way looking for financing.
The predictions of this numerical analysis are highly accurate, which allows economic institutions to minimize losses. In addition, it will enable them to measure precisely what interest rate to charge to make the business profitable.
Understood another way, this system offers numerical confidence like no other. FICO’s algorithm evaluates five critical areas that we will explain to you in CredHelper, each with a specific weight that reflects its importance in predicting risk.
Factor 1: Payment History (O Peso Maior: 35% to FICO Score)
This factor carries the greatest importance in the overall balance of the FICO Score. It makes up 35% of your overall score; besides, it answers key questions that determine whether you’re able to pay off your debts on time.
It determines your compliance with contracts and credits. It is proof that you keep your word on the agreed dates.
Understood another way, this system offers numerical confidence like no other. FICO’s algorithm evaluates five critical areas that we will explain to you in CredHelper, each with a specific weight that reflects its importance in predicting risk.
The Importance of Paying on Time: The Impact of Delays and Non-Payments
Lenders need to see a consistent history of the applicant before accepting the loan. A single late payment of more than 30 days can have a devastating impact, especially if your score is already high.
At that point, the system analyzes when payments are made on the agreed date, bankruptcies, foreclosures, and insistent collections. Keep in mind that an error or default from five years ago affects less than one in three months.
Factor 2: Amounts Owed (Debt Use: 30% to FICO Score)
The amount of debt you have in relation to your credit limits is almost as important as making timely payments. Indeed, it represents 30%. The credit use rate is a point to evaluate; you will not be able to depend too much on credit to cover your daily expenses.
The golden rule of credit utilization (Credit Utilization Ratio) and its ideal limit
The rule of thumb is to keep your credit utilization below 30%, which would be ideal. But those with the highest scores typically keep it below 10%. Here, the utilization of each card is evaluated both individually and with the total of all your credit lines combined.
Factor 3: Length of Credit History
It is the test of time based on predictability. That’s why the longer you’ve been responsibly managing credit, the better your score will be. This factor makes up 15% of the entire analysis.
This point discusses three main points: the age of your oldest account and that of your most recent account. Also, the FICO Score system analyzes the average age of all your accounts combined.
The value of old accounts and the average age of your credit lines
Canceling old credit cards could shorten your average history and eliminate proof of your financial longevity. Unless the card has an expensive annuity, it’s best to leave it open and use it once a year to keep it active.
Factor 4: New Credit (Buscando Crédito Novo)
This critical 10% is based on how often you apply for new credit. When you apply for a card or loan, what is known as a “Hard Inquiry” is generated. Activating multiple accounts at the same time represents a high risk.
The impact of hard inquiries and the opening of new accounts
Multiple new inquiries and activation can mean for the FICO score that you are in a difficult financial situation and desperately need money. In the case of credit cards, each app counts separately; it is advisable to limit the applications to at least six months between them.
Factor 5: Credit Mix (10%
Credit mix is a factor, accounting for 10% of the analysis, and it evaluates the variety of your accounts accurately. It’s not a determining issue on its own, but it helps to get a good score that is conducive to your goal.
There are two main types of credit that FICO wants to look at and analyze: revolving credit, which includes cards and personal lines of credit. Also, installment credit that merges student debts, auto fundings, and even mortgages.
The relevance of having a healthy combination of revolving credit (cards) and installment credit
Being successful in handling both kinds of credit tells that you are able to manage several payment structures and meet your economic responsibilities.
Here’s why someone with only credit cards may have a lower score than someone who also has a mortgage. Maintaining a healthy mix of credit will significantly benefit you.
Patience as a credit strategy
At the end of the day, the FICO Score is a reflection of your long-term financial habits. It represents the trust that the system has in you to grant you a loan. It offers a scientific, fair, and efficient solution to the credit uncertainty that arises.
To achieve success, you must prioritize your on-time payments and keep your balances low; with this, you are already 65% of the way through. The truth is that understanding these factors will allow you to take control and forge your own credit profile.
Remember that credit is a financial tool, and its effectiveness will depend on the skill with which you handle it. This way, you will not only get the best loans, but you will also get the best tools to dominate the economic system with an advantage.
