Your credit score — that all-important passport within the financial world — may be about to change. And it won’t necessarily be because of anything you did or didn’t do.
Fair Isaac Corp., the company that creates the widely used three-digit FICO score, is tweaking its formula. Consumers in good financial standing should see their scores bounce a bit higher. But millions of people already in financial distress may experience a fall — meaning they’ll have more trouble getting loans or will pay more for them.
Lenders use FICO scores to judge how likely you are to make timely payments on your loans. But they’re also used in lots of other ways, and can influence how much you pay for car insurance to whether you’ll qualify to rent a new apartment.
The changes, reported Thursday by the Wall Street Journal, don’t alter the main ingredients of your score, but they do take a more finely tuned view of certain financial behaviors that indicate signs of financial weakness. For example, consumers who consolidate their credit card debt into a personal loan and then run up the balance on their cards again will be judged more severely.
“The new scores reflect nuanced changes in consumer credit trends that we observed from our analysis of millions of credit files,” said Dave Shellenberger, vice president of product management at FICO, whose scores generally range from 300 to 850 (the higher, the better).
Here’s what you need to know about the new credit scoring system.
Q: Why change scores now?
A: FICO adjusts its scores every few years, drawing on consumer behavior and patterns that emerge from the vast trove of data it tracks. This time, the company is offering two new scores, FICO 10 and FICO 10 T, and both differ from the previous formula.
Given the strength of the job market and other factors, many consumers are managing their credit well. Late payment rates across all household debts are at their lowest levels since at least 2005, according to a recent analysis from Moody’s Analytics, and credit scores have been trending higher. (The last time the formula was tweaked, in 2014, it was expected to lift scores.)
Even so, a significant number of lower- and middle-income Americans are struggling, and consumer debt levels are quite high. And lenders are always trying to shield themselves from losses, should economic conditions deteriorate. FICO says the new scores will make it easier for lenders to gauge a borrower’s risk.
Q: What’s changing?
A: Some of the changes, such as carrying a personal loan as well as credit-card debt, affects both new scores. But there are more substantial changes involving the FICO 10 T version.
For example, instead of looking at just a static month of your balances, FICO 10 T will look at the past two years or more, which will give lenders more insight into how you’re managing your credit over time. That should mean your scores will better reflect the trajectory of your behavior. (VantageScore, a lesser-known score provider that is a joint venture of the three big credit-reporting companies, has already incorporated this into its formula.)
There are other changes, too. FICO 10 T will weigh recent missed payments more heavily and penalize those who use a high percentage of their overall available credit for long periods.
That could have consequences for a person who leans on credit cards during times of distress, such as a job loss. “But that person is probably a bad credit risk, unfortunately,” said Chi Chi Wu, a staff attorney at the National Consumer Law Center.
She said she worried that lower scores for such consumers could add to their troubles, making car insurance more costly or hurting their chances of finding housing — and make it harder for them to get back on their feet.
Q: How and when will the changes affect me?
A: Most consumers, or 110 million people, will see modest swings, if they see any change at all, according to FICO. But about 40 million people who have favorable scores are expected to gain about 20 points, while another 40 million with lower scores will probably see a drop.
But not every lender will use the new scores right away.
People applying for most mortgages will not be affected, at least for now. That’s because home loans guaranteed or backed by Fannie Mae and Freddie Mac, which include the vast majority of mortgages, are still required to use older versions of the FICO score.
Many other lenders are also using older FICO formulas, and it remains to be seen how quickly they adopt the new scoring method — or if they will decide to change.
The big credit-reporting companies — Equifax, Experian and TransUnion — will all offer the updated scores by the end of the year. Equifax will be first, sometime this summer, FICO said.
Q: How can I improve my score?
A: Because the FICO 10 T calculation has a longer field of vision, it pays to get your financial life in shape as early as possible before applying for a loan.
You still want to review your credit reports, which contain the raw data that power your scores, at each of the three big reporting companies. But now you should plan further ahead and check them even earlier, because an error about a missed payment can hurt you more, and correcting the mistake can take time.
You’re entitled to check each of your credit reports, free, once a year, through an authorized website: annualcreditreport.com.
The biggest shift, however, concerns the amount of debt you carry, experts said. In the past, people trying to polish their scores right before applying for loans were told to pay off their credit cards or get the balances as low as possible a month or two before submitting an application. That won’t work as well now.
“Paying off your card a month or two before you apply? That’s not the best advice anymore,” said John Ulzheimer, a credit expert who worked at FICO for roughly seven years before leaving in 2004. “You want to get your credit card balances down multiple months in advance, or at least have them trending down for months in a row and then have balances at a low before you apply. Your runway needs to be longer now.”
Despite the tweaks, the five broad factors that drive your FICO score haven’t changed. In general order of importance, those are your payment history, the percentage of your credit used, the length of your credit history, your mix of loans and how many new accounts you’ve applied for.
That means a lot of the traditional advice still holds: Don’t make late payments, don’t apply for more credit than you need, and keep outstanding card balances to a minimum.