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A
long awaited revision of how credit scores are calculated has finally
arrived, and knowing what has changed can help you improve your score
and save you money. The revised system puts more weight on your balances
and is more forgiving towards past mistakes. It also fixes some loop
holes, offers new opportunities and presents some new risk for consumers.
The three credit bureaus (TransUnion, Equifax and Experian) will be
putting the new formula into action in the first half of 2009 after
it was delayed by a lawsuit between the three credit bureaus and Fair
Isaac. They have since reached an agreement and are currently implementing
the new model for calculating FICO scores. FICO scores are used in 75%
of lending decisions and fully 90% of lending companies in the United
States largest lenders. Obviously a FICO score can have a large effect
regarding if an individual qualifies for a mortgage and the interest
rates they will be charged.
The new model that will be used for credit scores has both good and
bad elements for consumers, but for those who understand how the new
FICO model works they will end up with more benefits in the end. As
the saying goes, first the bad news.
The new credit scoring model is even more sensitive to how much of your
available credit you are using. That means that if a creditor slashes
your limit, which is happening all too frequently these days, then your
score could drop despite the fact that you are still carrying the same
balance.
Another potential problem is that the model responds more negatively
to consumers that have fewer open or active accounts. This can have
an undeserved negative effect since due to the current economic situation
many credit card issuers are shutting down unprofitable and unused accounts.
The good news?
The new formula ignores collections in which the original debt was less
than one hundred dollars. This is a big win for consumers who have had
their scores brought down by scores of little debts that have slipped
through the cracks. Things like unpaid parking tickets and other small
bills had an oversized impact on consumers FICO scores.
Past credit mistakes is another area where consumers are coming out
ahead. The new credit score calculations are much more forgiving about
previous credit setbacks like a repossession or charge-off as long as
current credit accounts are in good order.
Another area that the new scoring system modified is in “authorized
users”, they have limited the number of authorized users that
can benefit from being associated with a person with a good credit score.
If someone allows another person to be an authorized user the good credit
has a positive effect on the authorized users credit, however, credit
repair companies abused this by renting use of good creditors authorized
user status. It is hoped that the new limit on the number of authorized
users will deter abuse of the system and protect spouses and others
who have legitimate reasons to have their credit scores positively affected.
How to protect your score
One peril of the new system that might slip by consumers and hurt their
credit is that even if you pay off your cards monthly balances every
month your rating could still drop. Using less of your credit line that
you use the better, and with the possibility of reductions in the amount
of credit issued this could be an even smaller amount then you previously
thought. You shouldn’t get in the habit of charging up your cards
then paying them all off every month, ideally you shouldn’t be
using more than 30% of your available credit at any one time and even
less is better (Using only 10% would be great). If your credit limit
is cut it is worth it to attempt try to get the creditor to rescind
their decision, after all the credit markets are supposed to be unfreezing
right?
If one of your cards limits is slashed and there is nothing you can
do about it then move some of your balance over to another card. Regarding
your credit score it is always better to have smaller balances on more
cards then having a card that is close to being at its maximum.
Another tip is that you should not close your old accounts. Closing
accounts can never help, but it does have the potential to harm your
Fico score. You get more points for having an open account in good standing,
it increases your available credit and having a high number of closed
accounts can hurt you. It is even better to keep your accounts active;
it is optimal for consumers to have a variety of well managed active
accounts. This can be accomplished easily by having a monthly bill charged
to each account and then have an automatic payment made to ensure that
you don’t miss a due date.
You should also consider getting an installment loan to improve your
credit score. There are two main types of credit, revolving and installment
loans. A revolving loan, like a credit card or lines of credit, allows
you to build up and pay off your balances on monthly bases. An installment
loan usually has a fixed payment schedule that requires you to pay off
the loan by a set date. Home loans or mortgages are examples of installment
loans. Ideally your credit portfolio should include a balance of both
types of loans as the new FICO formula is even more sensitive to having
a mix of both loan types. The days of being able to have a high credit
score just by responsibly managing credit cards seem to be gone.
The new system should prove to be a benefit to those consumers who know
what the new formula judges to be important, so keep an eye on those
balances and good luck.
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