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Build a killer credit score in 2008
The formula for deciding who is most creditworthy is changing -- just as borrowed money gets harder to come by. Here are seven moves to maximize your score.
By Liz Pulliam Weston
Understanding how credit works is about to become even more important.
Not only has the subprime meltdown made almost all credit harder to come by, but Fair Isaac, the company that created the leading FICO credit score, has announced changes to its formula.
As a result, some behaviors that may not have hurt your score much in the past could cause your numbers to plunge, while other actions could help you boost your score more than in the past. For example:
* Applying for new credit accounts may hurt less.
* Having high balances on your credit cards could hurt more.
* Actively using the credit accounts you have may be more important.
* Having both revolving and installment accounts on your report could help you more, as the new formula is more sensitive to your ability to handle different types of credit.
Some things about the latest iteration of the score, dubbed FICO 08, will remain the same. FICO 08 will have the same 300 to 850 range as the classic FICO score in widespread use today, with higher scores indicating lower risk of default -- and thus winning you lower interest rates, cheaper insurance premiums, better deals on cell phones and lower utility deposits, to name just a few of the ways credit scores are used.
Fair Isaac says most consumers will see a slight increase in their FICO 08 scores compared with their classic FICO numbers, but others will see a drop.
The company says the new formula will do a better job of predicting who's a good risk and who's a bad one, particularly among consumers:
* With troubled, thin or short credit histories.
* Who are actively seeking credit.
* Who have "piggybacked" on others' good credit.
New reality, new credit rules
The piggybacking issue received some attention last year after credit-repair companies took advantage of a long-standing loophole regarding authorized users on a credit card. The loophole allowed one consumer's good credit history on a card to be imported into the credit report of another who was added to the card as an authorized user.
Those credit-repair companies arranged "rentals" of authorized user slots on the cards of people with good credit to artificially boost the scores of people with bad credit. Some of those with tarnished histories paid fees to be added to dozens of strangers' cards, lifting their scores more than 100 points.
Lenders protested, and Fair Isaac announced its new version of the FICO score would ignore authorized-user information.
The new formula also takes a closer look at people who have credit problems. Fair Isaac said FICO 08 will be less punishing to those who have had a single serious credit setback, such as a charge-off or a repossession, as long as their other active credit accounts are all in good standing.
Finally, the new formula reflects the fact that consumers today are more active seekers and users of credit, applying for more credit cards and other accounts than in the past. Having a "moderate amount" of credit inquiries on our credit reports -- inquiries that reflect our own efforts to open accounts -- won't be as detrimental to our scores under the new formula, said Fair Isaac spokesman Craig Watts. He declined to define "moderate amount," however, saying Fair Isaac isn't comfortable revealing more information about the formula.
Fuzzy language isn't the only uncertainty surrounding the new score. It's also hard to predict how long it will be before FICO 08 is in widespread use. Fair Isaac has released three previous upgrades to its formula in the past, and each time some lenders have been slow to upgrade to the latest versions.
The plot is even thicker this time. In 2006, the three credit bureaus started promoting a rival to the classic FICO score called the VantageScore, which they say does a better job of predicting risk. Fair Isaac sued the bureaus last year, accusing them of unfair and uncompetitive practices that it said harmed the FICO brand.
Although Experian and TransUnion will likely offer FICO 08 to lenders by spring, the third bureau, Equifax, says it won't offer the score until the lawsuit is resolved.
To hedge your bets and make sure you get the best possible score regardless of the formula used, consider the following:
* Scour your credit reports. Your credit score is derived entirely from the information on your credit reports at the three bureaus, and a single serious error can cost you big time. You're entitled to a free annual look at your reports from www.annualcreditreport.com. Dispute any accounts that aren't yours or any negative entries that are more than seven years old (or 10 years in case of bankruptcy). (Watch for impostor sites; see "How to get a credit report for free.")
* Don't be late. Skipping a single payment can knock your score from prime to near subprime territory overnight. Make sure all your bills are paid on time. Consider setting up automatic or recurring payments for all your credit accounts.
* Watch your balances. The less of your credit lines that you use, the better. Try not to use more than 30% of your credit card limits at any time during the month; using 10% or less is even better. Remember that the credit bureaus and your credit scores don't distinguish between balances you pay off and those you carry month to month; the balance that's reported to the bureaus is typically the one that shows on your most recent monthly statement. If you're in the habit of using a big portion of your credit limits -- because you travel on business or are chasing credit card rewards -- consider asking for higher credit limits. (You also could make two payments a month on each high-use card to lower the balance that's reported to the bureaus. To make this work properly, you'll need to make one payment just before the statement closing date on the account and a second after the closing date but before the due date. If you fail to make the second payment, you may be reported to the bureaus as being late.)
* Don't close accounts. Fair Isaac has made it clear that closing accounts can never help a classic FICO score and may hurt it. With FICO 08, that's even truer. The new scoring formula wants to see evidence that you are actively and responsibly using credit. So you get more points for having open accounts in good standing; conversely, having a higher proportion of closed accounts can hurt you more.
* Keep your accounts active. In the past, the biggest risk from letting accounts be inactive is that your lenders might close them, thus dinging your scores. Now simply having too many inactive accounts could count against you in some circumstances. Once again, the new scoring formula is looking for evidence you can responsibly manage credit. Consider keeping your oldest and highest-limit cards active by charging something to them each month (making sure to pay the balance off in full, of course).
* Piggyback the right way. You still can benefit from someone else's good credit under both the old and new FICO formulas by being added as a joint account holder to a credit card. In most cases, the other person's history with the card will be added to your credit reports; as long as the account remains in good standing, it can help your scores. But being added as a joint account holder involves more risk: You're now jointly responsible for the debt, whereas an authorized user typically would not be. Getting taken off the account isn't easy, either. A phone call from the primary cardholder might remove the name of an authorized user, but you often can't be removed from a joint account until it's closed.
* Consider an installment loan. There are two main types of credit: revolving accounts that allow you to build up and pay down balances, and installment loans that typically have fixed payments that require you to pay down your balance over time. Credit cards and lines of credit are examples of revolving accounts, while auto loans and mortgages are considered installment loans. The FICO formula has always rewarded folks who had and successfully managed both types, which is why getting an installment loan was often recommended as a way for people with troubled credit to rehabilitate their scores. The new scoring formula is even more sensitive to the mix of credit types people have and use. In the past, people were able to get and keep very high scores using only credit cards; it's not clear if that will still be true under FICO 08.
That doesn't mean you should march out and get a loan you don't need. Loans you've already paid off will continue to help your scores as long as they're still on your credit reports, and many lenders continue to report closed installment accounts for 10 years. But if you're trying to improve a low score, an installment loan is likely to help you even more under FICO 08 than it did under the classic FICO score.
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