This may lower your credit score. Even though you do nothing.
By Adam Garber
Philadelphia — FICO announced last week they are changing how they determine someone’s credit score, which helps determine if someone can get a loan, mortgage, or credit card. About 80 million people are expected to have their score change—half those scores are expected to go down.
The move, first reported in the Wall Street Journal, is happening after Fair Isaac Corp., which creates the scores, has developed new models from pouring over financial data for millions. The company has made similar adjustments in the past to the scores which typically range from 350 to 850 (the higher the better). Under the new system, individuals with higher scores will likely see their scores increase further.
Prior to this change, scores were based on snapshots in time that might not indicate whether you had issues paying off debt. But, the new system takes account for actions such as combining credit card debt into a personal loan, and then continuing to run up debt on your cards. This behavior could suggest challenges paying off debt or poor financial management.
“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.
Despite the strong economy, consumer debt has reached near record levels--similar to those seen during the 2008 recession. The nearly $14 trillion in American debt is mostly spread out between home, auto, student and credit cards.
So what can you do? In the short-term, not much. The change takes into account recent financial behavior. This longer view means its imperative you get your financial situation under control sooner rather than later. You should:
Review your current credit: You can get a free credit report at annualcreditreport.com from the three major bureaus. You should review the data for accuracy. An analysis of complaints to the Consumer Financial Protection Bureau (CFPB) found that inaccurate data was one of the top complaints to the agency. Problems were responsible for 96% of all credit reporting complaints. If you find an issue the CFPB may be able to help you rectify it.
In the past, experts advise individuals to have a low debt level right before applying for a loan. That will not work with the new models. You’ll need to get your debt load lower for months, or up to a year, prior to applying for a loan.
That being said, the core inputs for your credit score remain the same: payment history, length of credit history, loan mix, amount of credit currently in use, and how many new accounts you’ve applied for.
Paying on time, only applying for needed credit, and keep outstanding balances low shoudl help.
Consumers have time to get their fiscal house in order. Not all loan providers will switch over to the new scores. Mortgage applications, for instance, are required to use older FICO scores because of the backing of Fannie Mae and Freddie Mac. If you check your score through the major credit bureaus Experian, Transunion or Equifax, though, you may see the new score starting this summer.
