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Love it or hate it, your credit score is an integral part of your financial profile. Like a mirror into your money, it reflects your relationship with debt. That includes how much debt you have accumulated, how consistently you repay debt, and (most importantly for lenders) how likely you are to default on any new debt. All of that wrapped up in a 3-digit number that has the power to dictate your ability to borrow money, and at what rate.Last week, Fair Isaac Corp. announced plans to roll out two new credit-scoring models. The ‘FICO Score 10’ and the ‘FICO Score 10 T’ will both be available from the three major credit reporting agencies—Experian, TransUnion, and Equifax—beginning summer 2020. The new models will give lenders a more precise assessment of credit risk. For consumers, the change means two things:
- Your credit score may be changing (for better or worse).
- Action may be needed to prevent any negative effects on your all-important FICO score.
- In many ways, the new models are very similar to the models that exist today. Your score will still be determined by factors such as your payment history, how much credit you are currently using (30% or more of your available credit is a definite negative), the age of your credit history, your credit mix (how many types of revolving and installment credit you have), and any new credit accounts or lender inquiries (which indicate that you have applied for credit). What’s different about the new models is that they will now look at ‘trended data’ to give lenders a more precise reflection of your real credit capacity—or lack thereof.
The truth-telling power of ‘trended data’
Under the older formulas, your credit score would change month-to-month based on real-time credit usage. If you used more credit than usual over the holidays or during a big vacation, your credit score would fluctuate. ‘Trended data’ addresses that issue by looking at how you've managed your accounts over the past 24 months, creating a picture of your financial situation during that time. Of course, that’s great if you already have a stellar credit score and just happened to dip into your credit line temporarily. It’s not so great if, like Shelley, you’ve been ‘tricking the mirror’ by playing a financial shell game with your debt.Shelley figured out how to ‘manage’ her credit score years ago. Although she’s racked up a fair amount of debt (she’s been pushing that 30% utilization limit for years), she learned that by moving money from one credit line to another, she could make it appear like she was paying off her debt. She also figured out that personal loans weren’t factored into her FICO score, so she consolidated some of her revolving credit lines into a single personal loan. But instead of focusing on paying down the balance, she is only paying the interest on the loan. Her balance on the old debt hasn’t grown, but it hasn’t shrunk either. Instead of working to reduce her debt, she has just repositioned it—month after month, year after year. She has learned to play the game well.Shelley is not alone. While it’s true that not everyone has figured out how to work the system quite as effectively as she has, personal debt has been skyrocketing in recent years. The total amount of household debt hit a record of $13.21 trillion in 2018, with the average individual carrying $5,800 in credit card debt, more than $10,000 in auto debt, and $7,200 in personal loans. [1] It’s one reason lenders are concerned that the stage is being set for another type of financial crisis—and why the FICO models were changed to prevent consumers from playing financial shell games.Why your FICO score matters
Even if you don’t plan to buy a new house or a new car any time soon, a lower FICO score can limit your options in ways you may not even realize. Here are just some of the ways your score can impact your wallet and your life: - Cell phone providers use FICO scores to qualify customers for advertised rates—and T-Mobile estimates that as many as 50% of Americans don’t qualify for mobile deals advertised. [2]
- Landlords (including retirement communities!) use FICO scores when choosing renters. [3] I have clients with rental properties who use this method religiously. Good credit can be important later in life, too—especially if you plan to apply for housing at a high-demand retirement community where owners have the luxury of being very selective when choosing new residents.
- Auto insurance carriers use FICO scores to determine annual premiums. Having ‘good’ credit (a FICO score between 670 and 739) or ‘excellent’ credit (a FICO score above 740) can mean a difference of hundreds of dollars in premiums every year—even for drivers with outstanding driving records.
- 47% of employers use credit checks as part of their hiring processes. [4] Even if you’re older, you may choose to—or need to—work in your later years. The last thing you want is to let a less-than-perfect credit score keep you out of a job.
5 steps to manage your new FICO score
With the new changes on the horizon, now is the time to take charge of your FICO score to be sure it accurately reflects your financial behavior—and to take real steps to improve your debt profile if you’ve allowed credit balances to creep up over time. Here’s what to do before the new models kick in come summertime:
- Pay your bills on time. On-time bill payments are still one of the biggest factors in determining your credit score. Be hyper-responsible about paying every bill on time, every time.
- If possible, pay your credit cards in full each month. Under the new FICO models, borrowers who pay off their debt consistently are generally considered lower credit risks than those who revolve a balance from month to month.
- Avoid taking a personal loan to pay off revolving debt. Under the new FICO models, personal loans are not part of your debt profile. If a personal loan is used to consolidate debt and lower your interest rate, that’s ok. Just commit to paying off the personal loan as quickly as you can.
- Avoid taking on new debt. This is always a good rule to follow, but it will be even more important once the new scoring models are in place.
- Don’t play the shell game. The new scoring models do a much more precise job of determining whether you are reducing, maintaining, or increasing your balances over time. If you’re guilty of tricking the old system, use this as a wake-up call to erase your debt once and for all.
- If debt has been a challenge for you, improving your FICO score can also give you a new sense of self-worth. While your score gives lenders the information they need to determine what type of borrower you are, it is also a reflection of your entire financial life. An excellent FICO score tells you that you are paying attention to the details (opening your mail, paying your taxes on time, and balancing your spending with your income), making smart financial choices, and living a good, clean life—financially speaking. What a worthy goal! And if you need help making it happen, please reach out. As always, we’re here to help! [1] Sources: Mortgage Bankers Association, Dept. of Education, Federal Reserve, TransUnion and LendingTree calculations. [2] Introducing Smartphone Equality and Bringing Greater Fairness to the Wireless Industry, T-Mobile [3] What Landlords Really Look for in a Credit Check, NerdWallet [4] Society for Human Resources Management