How Your Credit Score Affects Your Financial Life – An Overview of How Your FICO Score Works

Note: While I receive compensation for my participation as a FICO brand ambassador, opinions are mine.

Before you go and apply for credit, it’s important to understand where your credit stands.

Knowing where your credit stands is helpful because one of the important things lenders will look at to determine whether to offer you a loan is the strength of your credit.

How lenders evaluate your creditworthiness

When you apply for financing, lenders use your credit reports and your FICO® Scores, that is based on the data in your credit reports, to determine your creditworthiness.

While your credit reports contain information collected on your track record of handling debt, your FICO® Scores summarize how likely you are to repay a new debt obligation.

It’s also important to know that while FICO® Scores are used by 90% of the top lenders, lenders use different versions of FICO® Scores depending on the type of financing you plan to secure (a mortgage versus an auto loan, for example). The FICO Score 8 is still the most widely used version, while FICO Score 9 is gaining traction and includes a more nuanced treatment of medical collection accounts.

How your credit score is used in lending decisions

Here are some of the most common scenarios where you will want to know not just your credit score, but the FICO® Score.

1. Opening a credit card

Whether you are applying for a credit card to take advantage of a beneficial rewards program for spending you’ve already budgeted or to start building a positive credit history, many credit card issuers evaluate how much of a credit limit to extend and the annual interest rate to charge, or whether a secured card will be required, by using the bank card version FICO® Score, in addition to the FICO® Score 8.

2. Financing a car

The average cost of a car can extend beyond $20,000. Through financing, you can pay for a car without coming up with such a large sum of money upfront. For this type of transaction, lenders typically use your FICO® Auto Score 8 as part of underwriting the car loan.

In addition, the way you manage your credit and your resulting FICO Score can also impact the cost of your auto insurance.

3. Refinancing student loans

One effective way to tackle student loan debt is to lower the total cost of the loans by refinancing with a new lender at a lower interest rate. Lenders who offer student loan refinancing rely, in part, on your FICO® Score to decide whether you are eligible to take advantage of lower interest rates.

4. Purchasing your first home

Buying a home is one of the largest purchases you will likely make that requires financing. Along with a healthy down payment, your FICO® Score, from the three nationwide credit bureaus, are used by home lenders to determine whether you will be able to secure the lowest interest rate possible.

How to best prepare before you apply for credit

A strong credit score is based on a solid history of positive financial habits. The best approach to establish good financial behavior and maintain a strong credit score is:

  • Pay all your bills and loans on time, every time
  • Reduce your overall debt to credit ratio by paying down debt
  • Use a minimal amount of your revolving credit available
  • Limit unnecessary credit inquiries
  • Resolve errors on your credit reports

Then you will place yourself in the best position possible when seeking credit throughout your financial journey. FICO works with more than 100 financial institutions to provide consumers with access to their credit score that matters through the FICO® Score Open Access program. To see if your bank is participating, click here.

You can learn more about how your FICO® Scores factor into the financing process at www.myFICO.com.

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