There are times when you need a large sum of money that you might not possess currently. This need has led to the invention of the loan or credit system. Today, we don’t even need to visit banks in order to loan money. We use credit cards. A single swipe can buy you things that you desire but cannot pay for at that moment. Now, where there is use, there is abuse. People often pile up huge credit and fail to pay up. Here is where credit score comes into play. It is a score awarded to a person based on his credit history. In simple words, it is a method by which lenders like credit card firms and banks determine the possibility or likelihood of the borrower paying his debts.
A credit score is nothing but a statistically calculated number that is derived from several different models available in the United States of America. And this is the way it came to life.
CREDIT SCORE MODELS
- Fair Isaac and Company or FICO
- Non-FICO or FAKO
FICO is actually a software company established in the year 1956 by engineer William Flair and Mathematician Earl Isaac and hence the name Flair and Isaac Company or FICO. Their product, the FICO score calculates the credit score of a person. This score can be used by lenders for decision making. Individuals can obtain their own FICO scores too. The company originally known as Flair and Isaac’s Company changed its name to FICO in the year 2009.
FICO score is influenced by both positive and negative information derived from your credit history. While not being able to pay your debt on time can have a negative impact, a good credit record will definitely help increase your FICO score. FICO scores vary from 300 to 850.
The credit data derived from your credit history forms the basis of your FICO scores. The derived data is categorized into five different groups: Payment history, Amounts owned period of credit history, kinds of credit in use and new credit. Different groups have different weightages upon which the FICO score is calculated. Payment history is the most important group with a weightage of thirty-five percent. Amounts owned, length of credit history follows with weightages of thirty and fifteen per cent respectively. Types of credit in use and new credit have the least weightage of ten per cent each.
However, it is important to note that this model is not rigid. The methods followed to obtain your FICO score can vary from person to person. The basic division of groups upon which the score is calculated may remain the same. However, the weightage on each group might vary in accordance with your credit data. Take, for instance, two people with two kinds of credit history. While one has a long history, the other has a very short history in comparison. It will be unfair to either of them if they are judged on the same model. This is why, the weightages on different groups are altered, based on the kind of credit history that a person has.
It is also a fact that as your credit history changes through time, the weightages of the groups also changes. Thus, the method in which FICO score is calculated for you also changes over time. The weightages mentioned above are typical. These weightages are entirely dependent on the credit history of the person whose FICO score is to be determined.
The different group on which your FICO score is calculated is explained below:
- Payment History: This is a very important factor that influences your FICO score if you have a long credit history. Payment History is what tells the lenders whether you have cleared all past debts on time. If you have a short or no credit history, Payment History has very low weightage.
- Amounts Owned: You might owe a lot of money with a lot of credit accounts. However, this alone does not lower your FICO score.
- Period of credit history: Normally, a longer credit history results into a better FICO score. But that may not necessarily be the case if you have a bad payment history. Similarly, a short credit history can also result in a high FICO score. FICO score takes into account the age of your first credit account, the aggregate ages of all your accounts and the age of your latest account. It also takes into account how long they have been used.
- Kinds of credit in use and new credit: FICO score will be based on the types of credit cards that you use, instalment loans availed, retail accounts, mortgage loans and finance company accounts. It is important to note that opening a large number of credit accounts during a short credit history can lead to lower FICO scores.
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