FICO, short for Fair Isaac Corporation, designs the credit scoring models that the vast majority of American lenders use to gauge borrowers’ creditworthiness. It recently announced that it will be releasing its new FICO Score 10 and FICO Score 10 T suites this summer, replacing the FICO Score 9 model from 2016.
Lenders can use any credit scoring model of their choice to assess potential borrowers. In theory, some lenders might keep using FICO 9 (or FICO 8, or FICO 7, and so on) to assess borrowers. But most lenders will probably adopt the FICO Score 10 Suite, given FICO’s promise that it will help them make more precise lending decisions and reduce the number of borrowers who default.
The new formula will continue to consider the 5 factors used in previous FICO credit score rating models:
- payment history
- amounts owed
- age of credit history
- credit mix
- new credit accounts
However, it will change the weighting given to each factor, punishing late payments and debt more severely than previous models. The new model will also expand into new areas, such as ‘trended data’, which takes into account how you have managed account balances over the previous 24 months.
How the New Credit Score Rating Model Could Affect You
It remains to be seen exactly how the average credit score will be impacted by the changes this summer. Some financial experts are already predicting the gap between good and bad credit scores will get wider. Here are several ways in which the new FICO credit scoring model could affect you personally.
Delinquencies will hit you harder. A delinquency goes on your credit report when you miss a payment by more than 30 days. Delinquencies have always been bad for your credit score, but will be even more damaging under FICO Score 10. You can’t do anything about past delinquencies, but you can avoid future ones by setting up autopay or putting payment reminders in your calendar.
Credit card debt will hit you harder. Another factor that lenders look at when assessing you is your level of credit utilization. According to the FICO blog, people in the highest quartile of credit scores use only 7% of their available credit limit, while people in the lowest quartile use 85%. Over-use of credit is another factor that is set to be punished even more harshly under the new scoring model. You can reduce your credit card utilization by using your credit cards less frequently. Another trick that can have a positive effect on your credit score is by asking your credit card issuer to increase your limit but continuing to spend the same amount as previously.
Personal loans will help you – if you use them wisely. If you’ve read conflicting reports about how personal loans can impact your credit score – there’s good reason for that. We recently reported that using a personal loan to pay off and consolidate debts can improve your credit score by up to 20 points. Thanks to the new credit scoring model, debt consolidation might bring even greater rewards than ever before. However, a personal loan can damage your credit score if you use the funds to pay for new things but don’t put any of it toward paying off old debt. And the way it looks, using a personal loan for ‘bad debt’ may have even more of a negative impact under the new rules.
New Credit Model Uses Larger Sticks and Carrots
If we can draw any conclusion from the new FICO credit score model, it is that the effect of your credit behavior will be more pronounced. What constitutes good credit behavior and bad credit behavior will remain the same. But good behavior will bring greater rewards, and bad behavior will lead to greater penalties.
Good credit behavior includes things like:
- Making payments on time.
- Not using more of your credit card limit than is necessary.
- Making sure your credit and loan balances don’t get out of control.
- Paying off overdue or outstanding balances sooner rather than later.
Opening and maintaining credit accounts in order to have a sufficient credit history (but not opening or applying for too many accounts in a small period of time, which is damaging).
Exhibit good credit discipline and your credit score rating could rocket this summer – putting you in a better position to get the best rates on mortgages, loans, and credit cards. But miss payments or rack up too much credit card debt and you could see your credit score suffer more damage than ever before.
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