New Credit Rating Formula Taking Effect
Your credit score might be about to change. And it could have nothing to do with anything you've done differently in handling your credit or paying your bills.
A new credit scoring model, called FICO 08, is finally on the verge of being adopted by lenders. The model, created by the credit scoring agency Fair Isaac, is an updated version of the formula lenders use to establish consumers' credit ratings, usually expressed as a number from 300-850. If you're thinking about taking out a mortgage, getting a new credit card or taking out any other kind of consumer debt, it could affect you.
Small debts to be ignored
The new model will mean higher scores for some consumers and lower scores for others, all without them doing anything different. The most significant difference from a consumer point of view is that the new model essentially ignores isolated late payments on debts under $100 that have gone to collection, so long as the rest of your credit history is good. Apparently, the assumption is that if you manage your other debts responsibly, that old dispute with your former cable TV over your final bill really doesn't matter.
Other borrowers can expect to see lower scores. The new rules particularly single out a practice called "piggybacking" that some consumers used to raise their credit scores. In piggybacking, a consumer with poor credit would persuade someone with good credit to add them to a credit card or other account as an authorized user. Being associated with a "good" account helped raise their score.
The new system essentially ignores piggybacked accounts, with one exception. For persons with good credit, having multiple authorized users for a credit card or other account could hurt your score - parents with teenagers beware.
The new scoring model has been in the works for about two years, but lenders have been slow to adopt it. However, Fair Isaac recently announced that about 400 credit card companies and banks are now using or testing the system, which was also made available to the three major credit reporting companies - Equifax, Experian and Transunion - in July.
Mortgage lenders slow to adopt
The initial impacts of the new system will probably be felt by credit card, auto loan and other relatively small consumer loan customers. None of the major mortgage lenders have embraced the new system yet, primarily because Fannie Mae and Freddie Mac, which back the great majority of home loans made in this country, have not yet signed off on it.
Aside from the changes above, the basics of the credit rating model will remain unchanged. Though most consumers are aware they have a credit score, many are unaware of how it is calculated.
How your credit score is determined
The FICO model is designed to predict the likelihood a borrower will be 90 days delinquent on a loan within the next 24 months. To do so, it takes into account the following factors.
Payment history - Your track record in paying your credit cards, mortgage, retail lines of credit and other debtors. 35 percent of your score.
Debt ratio: The total amount owed versus your credit limits with the various lenders you have an ongoing relationship with. 30 percent.
Length of credit history: How long your credit accounts have been open with various lenders. 15 percent.
New credit applications: How many applications for new loans or lines of credit you've submitted recently. 10 percent.
Credit diversity: How many different types of loans or lines of credit you have on your record. 10 percent.
By paying attention to these factors, consumers can focus on areas they need to improve on in order to raise their credit score and qualify for lower interest rates or other favorable loan terms. Note that an individual lender will likely consider other factors as well in assessing a borrower's credit risk, such as employment history and income.