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The good and the bad of the new credit scoring formula
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The new scoring system will allow "authorized users" on other people's credit cards to retain their own credit rating. (©istockphoto/Marcus Clackson)
The new scoring system will allow "authorized users" on other people's credit cards to retain their own credit rating. (©istockphoto/Marcus Clackson)
New credit-scoring system coming in '09
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By Andrew Housser
No matter where you turn in the media these days, you likely will find ads urging you to check your credit score -- but you might not know that a new way of determining credit scores is being rolled out this spring, and it will affect the way your credit is calculated.
Fair Isaac Corporation originally developed the FICO score method of rating consumers' credit histories. The three major credit reporting agencies - Equifax, Experian and TransUnion - each report consumer credit scores based on the FICO formula. This year, Fair Isaac will unveil a new version of its FICO credit scoring formula, called FICO 08 (because it was originally scheduled to appear last year).
The credit score is a number between 300 and 850 that measures an individual's creditworthiness based on credit history. Scores are calculated using mathematical methods that incorporate credit history, amount of credit used and available, number of late and on-time payments, whether any payments due are in default, and other variables. The score also is often called a "credit rating," which can be broadly categorized simply as "poor," "fair," "good," or "excellent."
FICO 08 is intended to help lenders better gauge actual risk by better differentiating good customers who have made one mistake from people who have multiple delinquent accounts. Ultimately, FICO 08 aims to help lenders better identify people who are most likely to default on loans. This new credit scoring template has both positives and negatives for consumers.
The positive
* Authorized user status cleaned up. In the past, credit rating for spouses who did not have their own credit cards, but were "authorized users" on their husband or wife's card, was based on joint history. FICO originally said being an authorized user would not provide any credit rating. This decision was because a few years ago, some companies started to rent "authorized user" status -- charging people with poor credit to "borrow" the credit rating of someone with good credit. The practice skewed credit for those individuals. But because people who are authentic authorized users protested vigorously, FICO 08 will instead tweak the system and retain authorized users' credit.
* Small problems hurt less. Individuals who had a small debt (less than $100) go to collections will not feel as much impact from that collection process. Previously, if you missed a $25 parking ticket, or you moved and the dentist sent your bill straight to collections, it could turn into a negative mark on your credit. While FICO 08 is not a license to run up bills, individuals will not pay as severely for a misunderstanding under the new template.
* Big picture matters more. With the older system, one big problem, such as a vehicle repossession, could torpedo your entire credit score. Now, if all other accounts are in good shape, one serious issue will not matter as much.
The negative
* More impact from less credit. Available credit will be a greater part of credit scores. Credit scores have always evaluated how much credit used as a percentage of available credit. But now that figure will weigh more heavily into the overall score. This change is especially important now, because some creditors are lowering credit lines, reducing the total amount of credit available. In addition, having fewer open and active accounts will have a negative effect on the score.
* A mix of accounts is needed. Credit scores will benefit most from a mix of credit cards and personal loans. If you have student or auto loans, this type of combination of loan types will help a score.
* Closed and unused accounts hurt. If you are paying off debt, closing those cards can decrease your credit score. Rotate the one credit card you use (and pay off monthly), or set the cards aside, but do not close the accounts. And if a creditor closes your account - they must notify you 30 days in advance - call to ask that they reverse the decision. To keep cards active, have a monthly bill, such as telephone, charged to a card. Set up an automatic payment or a personal reminder to be sure you do not miss a payment.
While the formulas used to calculate your credit score have changed, the main elements of a good credit score remain the same: using a variety of credit options, maintaining low balances that keep plenty of credit available, using credit responsibly and paying all bills on time and in full.
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