Tuesday, February 11, 2020

What You Need to Know About the New FICO Scores

Reprinted from Experian

Credit scores play a large part in determining interest rates and terms when you apply for a loan or credit card—and even whether you'll be approved at all. So the new FICO® credit scoring models announced January 23, 2020, may have you wondering how your credit scores will be affected.

What's Different About the New FICO® Scores?

Fair Isaac Corp., commonly known as FICO®, has built a new suite of scoring models that will be available from all three credit reporting agencies (Experian, TransUnion and Equifax) to lenders by the end of 2020. The new models will treat late payments and debt more severely, but will also now consider historical information about your credit card balances and payment amounts. Your FICO® Score will likely change as a result.

The FICO® Score 10 Suite, which includes the FICO® 10 Score and the FICO® 10 T Score, is the first redevelopment of the company's credit scores since 2014 when it released FICO® Score 9. And while new versions of credit scoring models tend to treat information similarly to prior versions, FICO® 10 includes several meaningful differences that are important for you to understand.

FICO® 10 T Considers Trended Data for the First Time

The FICO® Score 10 Suite will continue to consider the five main factors used in previous FICO® models to determine your FICO® Score: payment history, amounts owed, age of credit history, credit mix and new credit accounts.

Unlike previous FICO® versions, however, the FICO® 10 T variant expands into new territory, with the goal of giving lenders a more precise assessment of your credit risk. FICO® 10 T does something that no other FICO® Score has ever done: It considers your trended data.

Trended data, sometimes called time-series data, is information on your credit reports showing how you've managed your accounts over the previous 24 months, creating a picture of your financial situation during that time. And while trended data has been offered to lenders, it had never been included as a metric in any of your credit scores until another scoring model, VantageScore® 4.0, began considering it in 2017.

Regarding credit card accounts appearing on your credit reports, the trended data includes your balances, minimum payment requirements and the amounts you paid on your most recent credit card statements going back 24 months. This allows the credit scoring model to differentiate consumers who pay their credit card debt in full each month (known as "transactors") from those who carry over, or "revolve," a balance from month to month. Consumers who pay their credit cards in full each month are generally considered lower credit risks than those who revolve a balance from month to month.

Trended data also allows a credit scoring model to determine whether you are reducing, maintaining or increasing your balances over time. These factors are considered by the newest scoring models because they help predict credit risk, which enables both consumers and lenders to make more responsible credit decisions.

"FICO® invested in the development of both FICO® 10 and 10 T rather than a single score in order to provide lenders with unparalleled flexibility to select which approach works best for them," says Ethan Dornhelm, vice president of scores and predictive analytics at FICO®.

What does this mean to you? To make your trended data work for you and not against you, it will be more important than ever to pay your bills on time and pay down or, ideally, pay off your credit card balances well in advance of future credit applications. These trended payments will appear on your credit reports, and FICO® 10 T and VantageScore 4.0 will likely reward you for reducing your balances. Of course, you'll get the added benefit of saving money on interest fees as well.

Delinquencies Will Hurt Scores More Under FICO® 10

Delinquencies on your credit reports occur when you miss payments on your credit obligations. Lenders generally report these late payments to the credit bureaus once you have gone at least 30 days past the due date. Late payments on your credit reports can lead to lower credit scores for many years, regardless of the scoring model or generation of credit score.

With the FICO® Score 10 Suite, the impact of late payments is more pronounced than with prior FICO® Score versions. This means consumers who miss payments are likely to experience a more severe drop in their credit scores under FICO® 10 than under previous FICO® scoring models.

The best way to avoid the impact of late payments is to make all your payments on time—no exceptions. Setting up autopay to send even just minimum payments ahead of the due date will go a long way toward keeping your scores in good shape (and you can always add a larger payment during the month as well). Staying current on your obligations is a great way to build and maintain solid credit scores, regardless of the scoring model.

Credit Card Debt Will Have a Bigger Impact With FICO® 10

One of the most important metrics that credit scoring systems consider is the amount of your credit card balances compared with your credit limits. This is called "credit utilization," and is calculated by dividing your credit card balances by your credit limits. For example, if you have $5,000 of credit card debt and $10,000 of total available credit, then your utilization is 50%. The lower that percentage, the better it is for all of your credit scores.

While credit utilization has long been a component of credit scoring models, its impact will be more pronounced in FICO® 10.

You can achieve lower utilization in several ways. First, if you use credit cards sparingly and avoid large balances, your utilization will likely remain low. And if your credit card issuers increase your credit limits, your utilization percentage will go down—unless you charge larger amounts to those credit cards. Finally, if you leave your unused or infrequently used credit cards open rather than closing them, your scores will continue to benefit from the unused credit limit in the form of lower utilization.

Personal Loans Might Lower Your FICO® 10 Score

Early reports about FICO® 10 revealed that personal loans would be treated differently than they were in prior FICO® versions, and that consumers might be penalized simply for having personal loans on their credit reports. This is a notable difference in how FICO® Scores have traditionally treated personal loan accounts.

Personal loans, sometimes called signature loans, are unsecured installment loans that are commonly used to pay off credit card debt. This process, called debt consolidation, involves taking out a personal loan for the purpose of paying off higher interest credit card debt.

Debt consolidation has long been recognized as not only a smart financial move, since interest rates on personal loans can be much lower than those on credit cards, but also a smart credit score improvement strategy. When you convert revolving credit card debt to an installment loan, your credit scores may improve. Even under FICO® Score 10, this strategy is still a good idea if you're trying to eliminate expensive credit card debt.

"While there are certain high-risk consumer behaviors associated with the use of unsecured personal loans, there are also circumstances where a consumer's FICO® 10 and FICO® 10 T score can benefit from the presence of an unsecured loan," says Dornhelm.

One notable exception, however, is if you use those newly paid off credit cards to make new purchases—building up new balances while you're also paying off the consolidation loan. In this situation, your score will likely take a hit under FICO® 10. This emphasizes the importance of avoiding a scenario where you pay off or pay down credit card debt with a personal loan, but then get right back into credit card debt again.

What Else You Need to Know About FICO® 10

If you have a good credit report and good FICO® Scores already, you're likely to have an even higher score under FICO® 10. Consumers with good credit will tend to score higher under the newer scoring models.

If you have poor FICO® Scores already, you're likely to have a lower score under FICO® 10. Consumers with poor credit tend to score lower under the newer scoring models.

If your credit report at any of the credit reporting agencies does not qualify for a FICO® Score, your credit report will not qualify for a score under FICO® 10 either. Credit reports must meet a variety of minimum data standards to be considered "scoreable" under any of the FICO® credit scoring models. 

In early 2020, however, Experian will begin offering Experian Lift to lenders, which will help them to score a consumer with no traditional credit file. This could help more consumers qualify for credit products.

The FICO® Score 10 range will be the same as previous versions of FICO® Scores: 300 to 850.
If you use Experian Boost™† as a strategy to improve your FICO® and VantageScore credit scores at Experian, this will also continue to work with FICO® 10 and 10 T.
The Bottom Line

When it comes to managing your credit to earn the highest scores possible, the traditional advice still works—but works better if slightly adjusted.

Normally, consumers who pay their bills on time, maintain low credit card balances and apply for credit sparingly are well on their way to earning great credit scores. All of this is still true. However, because FICO® 10 T will now consider trended credit data and can see if you pay your credit card balances in full each month, it further underscores the importance of moving away from carrying balances on your cards.

Ultimately it will be up to lenders to decide when they will convert to the FICO® Score 10 Suite—or whether they will convert at all. If they do convert, the lender will get to choose whether they will use FICO® 10, FICO® 10 T or both models.

1 comment:

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