How Does a FICO Score Work?

Application

Consumers apply for credit from lending institutions, credit card companies and/or department stores. Applications for lines of credit will include name, Social Security numbers, date of birth, employer and current address. Consumers who have never applied for credit may need co-signers to get their credit history started.

Lenders

Lending institutions contact one of the three major credit-reporting agencies if the consumer is applying for credit in the United States. Most countries have a credit agency equivalent that houses the credit record of the consumer. Consumers who move from one country to the next don't have portable credit ratings. It may be necessary for the consumer to work in a country for a significant period of time before applying for credit.

Lender Communicates with Fair Isaac Corporation

The credit-reporting agency uses the FICO decision management tools to develop a score for each consumer. Fair Isaac is the brain child of an engineer and a mathematician. The use of the tool dates back to the 1950s. It has evolved over time to become an instrument that gauges consumer behavior on past history.

FICO Formula

FICO uses mathematical algorithms that aggregate past payment history, defaults on loans, court decisions and available credit on each line of credit. Scores may vary from one agency to the next because of the information that each agency has garnered. This is why is it crucial to check all pertinent agencies annually and update all information.

Lender Decision

The credit reporting agency uses the information supplied by FICO and the consumer to make a decision about credit. Inquiries may by lending institutions are called hard inquiries and may decrease the consumer's FICO score if multiple inquiries are made. Inquiries made by the consumer are called soft inquiries and don't affect the FICO score.

Consumers Control FICO Score

Paying off and closing credit cards will not automatically increase a FICO score. The score is based on a formula that uses available credit to determine credit worthiness. FICO scores of 720 and above place consumers in a position to have better interest rates on loans, making homes and cars more affordable. Paying bills late or defaulting on a loan will lean to negative items on a credit score. Having more than a third of the total line of credit charged on a card may also lower credit scores.