The term FICO, which was derived from the software developed by Fair Isaac and Company, provides lenders information about the future risk of lending to borrowers based on a borrower's credit payment history.
Creditors who are considering loaning money to consumers for car loans, personal loans, credit cards or home mortgages need to know the risk they are taking and the chance the money will be repaid by the borrower. A borrower's FICO score can give them an indication of the lending risk.
The information is gathered and disseminated by three major credit reporting agencies Experian, TransUnion and Equifax. Lenders use the information by these agencies to determine if a customer or borrower will be a good credit risk. Credit scoring is not fool- proof and a score is not always a good indicator of whether or not a customer will be a good or bad risk, but it can provide valuable information to lenders. Lenders frequently use the FICO scores in their lending decisions, but other techniques are also used to determine the interest rates charged for borrowing money. The interest rates charged can also vary for different credit products.
Credit scores are numbered between 300 to 850, and the higher the score the more favorable the terms of the loan. Consumers or borrowers who have a low FICO score may have difficulty qualifying for a loan, or if they do qualify, they may be charged higher interest rates. It is important to remember that each of the credit reporting agencies may have different FICO scores for a consumer, and a consumer's FICO score can change over time.
There are 5 groups of data which can affect a borrower's credit score including: payment history, the amount of debt the consumer owes, the length of the credit history, new credit and the types of credit the consumer uses. Payment history can include information related to specific accounts (water, gas, credit cards and loans), the delinquency of specific accounts, and the presence of any adverse items (Bankruptcy, suits or Liens). Amount owed includes the amount of money owed on certain accounts and the amount outstanding on installment loans. Length of credit history includes the amount of time on all accounts opened and the amount of time since there was activity on the account. New credit history is the number of recently opened accounts and the amount of recent credit inquiries. Types of credit used is determined by the type of accounts the consumer has open and uses (credit cards, personal loans, home loans and retail accounts).