Consumers who are already fretting about a miserable credit score will have yet another reason to be freaked out. The rules are changing, and not in a good way for those who face financial troubles.
And if you’re already credit-challenged, it’s going to be even more important to pay all your bills on time, never miss payments, and avoid running up those credit cards to the maximum available line of credit.
“Everyone knows that missing a payment is bad. Everyone knows that excessive credit is bad. Now, it’s just worse,” said John Ulzheimer, a credit expert who formerly worked for credit-scoring company FICO and credit bureau Equifax.
“People who have elevated risk are going to score lower,” Ulzheimer said.
The Fair Isaac Corp. in late January announced its latest version of the popular FICO score — dubbed the new FICO Score 10 Suite. It’s a bit like an overhaul of an iPhone, and not every lending outfit is going to immediately jump on board and use the latest technology.
The new FICO Score 10 Suite model will be available to lenders this summer. But consumers must start paying attention to the changing credit scoring landscape now if they want to improve their scores.
How your credit score adds up will influence the interest rate you’d pay when refinancing a student loan, borrowing money to buy a car, qualifying for a credit card with generous rewards, and applying for a mortgage.
FICO credit scores
FICO says the new model is designed to reduce the number of defaults for credit cards, car loans and mortgages.
The improvements, FICO maintains, can “help lenders avoid unexpected credit risk and better control default rates, while making more competitive credit offers to consumers.”
FICO scores — designed to be an independent standard measure of consumer credit risk — are used by many major lenders, including 25 of the largest credit card issuers, 25 of the largest car lenders and tens of thousands of other businesses.
FICO scores range from 300 to 850. A score of 700 and above is considered good but 800 and higher is the sweet spot for scoring better rates on car loans, credit cards and mortgages. The average national FICO hit the all-time high of 706 in September 2019.
Your credit score helps determine the interest rate you’d pay when you borrow. Those with ultra-low scores need to worry if their score is good enough to even qualify for a loan at all.
One analysis by LendingTree compared the range of credit scores labeled as “fair” (those in the 580 to 669 range) and those dubbed “very good” (740-799) to measure the difference in borrowing costs.
A consumer taking out a car loan for around $25,000 could save nearly $3,850 in interest over the life of the loan if they had a “very good” credit score, compared with a “fair” score, according to the LendingTree data.
On a $250,000 mortgage, the analysis indicated that the lifetime savings could be about $40,000. All just because you qualified for a lower interest rate because you had a higher credit score.
Equifax, Experian, TransUnion make changes
Some lenders have expressed concern that the average score has edged up because of some easier grading, if you will, in recent years.
Back in 2017, for example, the three national credit bureaus — Equifax, Experian and TransUnion — agreed to remove and no longer include tax liens, most civil judgments and other information relating to some medical debt.
The change was pushed by consumer watchdogs and was part of an agreement with 31 state attorneys general. The theory was that some consumers had been wrongly harmed when mistakes had been made and someone else’s tax lien showed up on your credit report.
But Ulzheimer maintains that credit scores, as a result, went up when this objectionable information was no longer included in credit reports.
“All of this is great for consumers who have tax liens, judgments and medical collections but it’s not great for scoring models and their users,” he said.
A new scoring model, he said, is needed to make up for those restrictions.
TransUnion said modern credit decisions require a modern approach, such as using multisource data.
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VantageScore Solutions, a consumer credit-scoring model, already uses some methods to better review longer term trends for how you’re managing credit. VantageScore was created through a joint venture of the three major credit bureaus, Equifax, Experian and TransUnion.
Both FICO and VantageScore are turning more toward what’s called “trended data,” which attempts to take into account how you’ve been taking on credit over several months.
Trended data displays your balance, payment amount and minimum payment due on your credit cards for the past 24 months.
Check your credit report
First, take the time to review your credit report annually at www.annualcreditreport.com. Or call 877-322-8228. You want to make sure that what’s stated on the report is correct — and correct anything that needs to be corrected — long before applying for a loan.
What’s on your credit report influences your credit score.
Typically, the recommendation has been to review your credit report a few months before applying for a loan in order to spot and correct any mistakes — say a credit card that you never opened appears on your report.
Going forward, Ulzheimer said he’d recommend that people start reviewing their credit reports six months or more before taking out a loan.
You’d want the data to show that your balances have been going down or paid off for several months in a row before applying for a loan.
The new FICO program analyzes whether you’ve made a consistent effort to pay down your debt and not take on more credit.
Such data, Ulzheimer said, looks at whether you pay off your credit card bills in full each month, or revolve a balance. The credit scoring model also considers the size of the balances, as well as whether your balances are trending up or down or staying steady.
New FICO model
First the good news: Your credit score isn’t about to get dinged in the next few months. It’s going to take some time, maybe even a few years, for this new scoring system to all come into place.
“People shouldn’t wake up on Monday freaking out on this,” Ulzheimer said.
And consumers need to realize that lenders use a variety of scoring models and some won’t be using the new FICO Score 10 Suite model. They may use other scoring models.
Carma Peters, president and CEO of Pontiac-based Michigan Legacy Credit Union, said where some consumers could feel a bigger impact is perhaps when they apply for a credit card, say at a department store, and the card issuer uses an automated decision model that quickly rejects a consumer with a lower score.
Other lenders, though, such as a credit union or smaller banks might look at more than just the credit score and take other factors, such as a customer’s history, into account when reviewing a loan application, she said.
Anyone who plans to apply for a loan should avoid late payments on their bills, take time to pay down their credit card debt over several months before applying for a loan, and be careful with taking on new credit.
You do not want to pay off your credit card debt by consolidating with a personal loan —or a favorable rate credit card — only to go out an load up on more debt. It’s clearly one trend you want to avoid in the future.