Beginning this summer, the latest iteration of the ubiquitous credit scoring model known as the FICO Score will debut to either the delight or dismay of millions of consumers. That’s because the model incorporates a rejiggering of the formula for how our credit history is viewed when lenders make decisions. In the final analysis, good scores will rise a bit, while poor scores will tick lower, but the impact on most of us will be minimal.
The concept of a numerical assessment of creditworthiness began in 1956 when Bill Fair and Earl Isaac turned the power of data processing to the task of analyzing prior credit behavior in an effort to predict future repayment. Since that time, the Fair Isaac Company (FICO) has released several revisions and improvements to the FICO scoring system, which is utilized in over 90% of all consumer credit decisions in the US.
The newest version, known as FICO Score 10, tweaks the weighting of various aspects of an individual’s borrowing record as reported by the three major credit reporting agencies Experian, Equifax and TransUnion. One option available with the new tool is FICO 10T, which analyzes recent trends over 24 months to improve prediction accuracy. Version 10 will also weigh personal loans more heavily, so a consumer who takes a personal loan to pay down credit cards may be penalized, since the potential exists to run the balances back up.
According to the company, FICO 10 may reduce defaults by as much as 10% among new credit cards issued, 9% for auto loans and 17% of new mortgage loans compared to the current FICO Score 9. Individual lenders will decide when or if they wish to migrate to the new system.
Fair Isaac estimates that roughly 40 million borrowers with good scores (680 or higher) may see their numbers go even higher, while an equal number with “poor” FICO scores likely will experience a decline. Estimate of the magnitude of changes are in the range of 20-25 points.
It may take a while for the new model to gain wide acceptance: most lending decisions are still made using older versions of FICO. Although Version 9 was released back in 2014, the majority of lenders still rely on the 2009 FICO Score 8. And mortgage lenders who make loans guaranteed by Fannie Mae and Freddie Mac are subject to those agencies’ standards that require the use of different models for each reporting bureau (from version 2 through version 5), so the home loan market is unlikely to make the change any time soon.
Despite the pending release of FICO 10, it is still essential to focus on the good old fashioned, tried and true methods for building and maintaining a solid credit file.
Pay on time. Seems obvious, but a record of timely payment remains the biggest single component of your FICO score, representing about 35% of the total in Version 9.
Keep balances low. Part of your score (roughly 30%) is determined by what is called the “utilization rate” or the percentage of available credit actually borrowed. Point in the direction of under 30% and aim for 10%.
Don’t apply too often. Frequent applications for new credit cards or lines of credit, even if not utilized, affect your overall score negatively. Only apply if you need the credit.
Check your report. Get your free copy of each agency’s file at AnnualCreditReport.com and review for errors. Reporting agencies are required to correct any incorrect data at your request.
New FICO models come and go, but the basics of good credit are immutable.
Christopher A. Hopkins, CFA