What Is a FICO Score?
A FICO score is a number that represents your "lendability," or your overall likelihood of paying back a loan. For most intents and purposes, it's synonymous with a credit score, though your FICO score might differ slightly depending on which credit bureau you use to calculate the score.
Even though a FICO score refers to your personal credit score, lenders use it to determine whether or not you qualify for anything from a mortgage loan to a small-business loan. Knowing more about the score and how it’s calculated can help you improve your personal credit score and better understand your options when applying for a small-business loan.
What is a FICO score?
A FICO score is a three-digit number that can range from 580 (or below) to 800 (or above). Credit bureaus calculate your FICO score based on your payment history, the amount of debt you've accrued, and how long you've maintained a line of credit, among other factors. Lenders will use your FICO score to determine whether or not you qualify for a loan and, if so, what your interest rate will be.
The lower the number, the worse your credit score—and the less likely you are to get a good loan with a good interest rate. On the flip side, a higher number means a higher score, which makes you more likely to secure a solid loan with a reasonable interest rate.
The FICO score was first introduced in 1958 by engineer Bill Fair and mathematician Earl Isaac. (FICO stands for the Fair Isaac Corporation.) The goal was to help creditors make data-driven decisions before they offered a loan to a borrower.
In 1991, the FICO score was released to the three major personal credit bureaus: Experian, Equifax, and TransUnion. In 1995, mortgage companies Fannie Mae and Freddie Mac started using the FICO score for mortgage lending.
Why is your FICO score important?
Since its introduction to the major credit bureaus in the early ‘90s, banks and other creditors have used the FICO score to evaluate a borrower’s creditworthiness for everything from auto loans, home mortgages, credit cards, and small-business loans.
Yes, your personal credit score, or FICO score, might not be the best measure of whether or not your business will successfully repay a business loan. But in tandem with some other metrics, it does help a lender answer three very important questions:
1. Can your business afford to repay a loan? Your FICO score includes your current level of debt, which helps lenders determine if you can afford to take on extra debt while maintaining a stable debt ratio. (Additionally, lenders will look at your business’s revenue and cash flow to see if you can afford the loan.)
2. How likely is your business to repay a loan? Your credit history—including whether or not you've defaulted on loans or made any late payments—is reflected in your personal credit score. Lenders use your FICO score to generalize about if you’re the type of borrower who typically meets financial obligations.
3. How likely is your business to make each and every loan payment? Your FICO score plays into this question too. Lenders are trying to determine what you’ll do in the future based on what you’ve done in the past. They’ll look at both your business credit profile and your personal FICO score to make that determination. The thought is if you make all your loan payments regarding your personal credit obligations, you will likely do the same with your business obligations.
There are circumstances where a business owner with a weak personal credit profile might still be able to successfully make loan payments. But lenders often see a correlation between how a borrower meets their personal obligations and how they meet their business obligations.
So as a small-business owner, you should assume that your personal credit score, or FICO score, will always be a relevant factor in qualifying for a business loan.
How is your FICO score calculated?
The formula for calculating your FICO score includes the following five metrics:
- Payment history (35% of your score). Late payments, bankruptcy, settlements, charge-offs, repossessions, and liens will all reduce your score.
- Debt-to-credit ratio (30% of your score). A debt-to-credit ratio compares the amount of credit you have available to the amount of credit you use. Keeping your credit use to around 15% to 20% is best, and maxing out your available credit each month isn’t recommended.
- Length of credit history (15% of your score). Lenders will look at the average age of the accounts on your credit report, as well as the age of your oldest account. The longer, or older, the credit file, the better. In other words, closing old accounts may not be the best strategy for building a strong personal credit score.
- Credit accounts (10% of your score). When it comes to debt, it’s best to have a blend of different account types. For example, a mix of a mortgage, an auto loan, a credit card, and revolving installment debt reflects better on your report than a couple of credit cards.
- New credit inquiries (10% of your score). Every time you apply for a new credit card or new credit account, it can reduce your score a few points. Fortunately, when you’re shopping for a mortgage, an auto loan, or a student loan, the credit bureaus recognize there will likely be multiple inquiries for the same thing and won’t ding your credit for each one. They will typically only ding you for the first inquiry.
Generally, if you apply for only the credit you really need and make every single payment on time, you will build a strong FICO score over time. And for better or worse, there really is no shortcut: slow and steady is the only way to win this race. Consistent behavior over time is what the credit bureaus reward with a good FICO score.
What does your FICO score mean to lenders?
Your FICO score isn't the only element of your credit history lenders consider, but it absolutely impacts your loan application. Take a look at where your score sits on the scale and see how it’ll affect your lending opportunities.
Below 579: Bad
Some lenders will still work with a borrower who has a bad FICO score—but the options are quite limited. Not only that, but borrowers with a low FICO score should expect to pay a higher interest rate on both consumer and business financing on any loan they're able to secure. Most importantly, a small-business owner with this low of a personal credit score is unlikely to qualify for a traditional business loan from a bank or credit union or for an SBA loan.
A poor rating is also considered a higher-risk credit score and will likely include higher interest rates and less favorable terms. As a consumer and business owner, you will likely have limited loan options if your FICO score is in the poor range, though you can still find some financing options (and at the very least, you'll have more options than you would with a bad credit score).
A score with the 620 to 679 range is considered a moderate-risk score. As a business owner with a fair FICO score, you might be able to secure a small-business loan, but it won't come with the most favorable terms or the lowest interest rate.
Additionally, a traditional loan at the bank is unlikely. And the FICO threshold of 660 is usually at the bottom of what the SBA will consider.
Anything between 680 and 739 is considered a good score. A borrower with this type of score should have few to no issues obtaining financing for either personal use or business use. Borrowers with a score in this range should expect to see more approvals and better interest rates.
740–799: Very good
If your FICO score is within the very good range, you’re considered a low-risk borrower and should have no problem qualifying for a personal loan or a business loan. Business loans will be especially easy to qualify for if you have a healthy business and cash flow.
Above 800: Excellent
If your score is considered excellent, you should absolutely qualify for a personal or business loan (as long as you meet the lender's other criteria). You can expect to have multiple financing options along with the best interest rates and most favorable terms.
Other lending considerations
For the record, your FICO score might be the most important evaluation of your lendability—but it isn't the only thing banks and other lenders consider.
In addition to your FICO score, the credit bureaus also consider information on your public record, such as your name, birthdate, address, and employment. Your score will also be influenced by any information (both good and bad) your creditors report about your credit history. Any bankruptcies will also be reported to the credit bureaus.
And if your FICO score is in the garbage, you might not be entirely out of luck. The 1996 Fair Credit Reporting Act allows you to add a 100-word statement to any reports that have information you may dispute or want to explain. This is an opportunity to share any extenuating circumstances like a divorce, long-term illness, or job loss that may explain your less-than-perfect FICO score.
Because lenders consider your personal credit history when evaluating your business loan application, it’s crucial to take actions that will bolster your FICO score. Many lenders today—including traditional lenders like banks and credit unions and nontraditional lenders—factor your personal score into how they rate your creditworthiness and whether or not they’ll approve your business loan application.
Although a strong personal credit score might not guarantee a loan approval, a good score will give you more options when you look for financing. And if your current FICO score is depressingly low, please don't give up hope: FICO scores can (and do!) change over time, and implementing wise financial habits will absolutely pay off in the long run.
Interested in learning more about business financing? Our ultimate guide to small-business loans will tell you more about how to get a loan.
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