Credit Scores—How the Rules Are Changing

Each time we buy a new car, refinance a mortgage, or apply for a credit card, lenders pull our credit report to check the credit score. Credit scores are a convenient little number that enable lenders to evaluate a borrower’s credit worthiness in a split second.

Credit scores, or FICO scores, were developed by the Fair Isaac Corporation as a means to give lenders an easy way to determine how likely a potential borrower is to pay off their loan. The credit score is calculated from a person’s behavior on a range of variables predictive of how responsibly they will handle future credit. FICO scores range from 300 to 850, with scores higher than 700 considered excellent. The average FICO score for U.S. consumers is around 690.

In January of 2009, FICO introduced a new credit-scoring model called FICO 08. FICO 08 so far is only available from TransUnion, one of the three major credit reporting agencies, but it is expected to eventually become industry standard. Here is how the new credit scoring rules change the way lenders look at credit behavior.

1. Credit utilization is more important than ever - Credit utilization is a measure of how much of one’s available credit a consumer uses. The credit utilization ratio has always been highly important, making up an estimated 30% of the FICO score. In FICO 08, it becomes even more important. People with high credit card debt in relation to their available credit are considered to be higher risk than before and hence get zapped more.

Who loses out? Consumers with balances close to their credit limit are likely to see their scores drop lower with FICO 08. Also, consumers with too few open accounts or people who close accounts (lowering total credit available) may see lower scores.

2. No more piggyback rides. FICO 08 is particularly bad news for people seeking to improve their credit score through piggybacking. In credit card piggybacking, a person will pay a fee to get listed as an authorized user on the credit card of someone with good credit history. While the “authorized user” doesn’t actually get to use the card, the credit history of that card will show up on his or her credit report and help increase the credit score. A whole industry of piggyback websites have sprung up to match up people in search of a “credit score fix” with high credit score cardholders willing to sign them up as an authorized user on their card in return for a one-time fee.

Who loses out? FICO 08 cracks down on people trying to game the system through piggybacking. However, people who add a legitimate authorized user, such as a husband adding a wife or a parent a child, will not be punished. How will Fair Isaac tell the difference? That’s an industry secret, and anybody’s guess.

3. Small sins are forgiven. Haunted by a collection agency trying to collect that $87 utility bill from your last residence which you’re sure you already paid? Well, fret no more. Minor slip-ups, like third-party collection debts under $100 will no longer have as serious an impact on a consumer’s score. FICO 08 will bypass 3rd party collections or public records with amounts that originally were less than $100. Pay attention to the exclusions, however. If the original amount was over $100 but has been paid down to less than $100, it still counts against the score. Similarly, collections from the collection department of a credit card company still will be a strike against you, even if less than $100.

In addition, FICO 08 will change the weighting of factors considered in the current FICO score, including the length of your credit history, and the number of open lines of credit. The Fair Isaac Corporation predicts that two people who have the same score today could have very divergent scores with FICO 08. Overall, however, the new formula is expected to increase the score for more people than it will decrease.

Published: May 22, 2009