As you may have noticed, many credit card issuers have begun increasing their interest rates and shrinking the credit limits of their clients. Now comes news that Americans have something else to contend with when it comes to their credit score – FICO 08.
Why is this so important? Your FICO score determines how far your money will go. Most major financial institutions use your FICO score to determine what type of risk you are – the higher the risk, the more interest you pay on loans. The new scoring model, which the Fair Isaac and Company began developing two years ago, recently took effect in early 2009. While the general parameters used to determine your overall credit score have remained the same, the new scoring model attempts to refine the process used to predict borrower default.
Most of the changes within FICO 08’are designed to more accurately depict the current credit climate. As a result, the new scoring model will forgive occasional slip-ups; however, repeat offenders will be more adversely affected. For instance, accounts that are forwarded to collections that total less than $100 will matter less in the calculation of scores. Obviously, collections accounts are something you want to avoid; however, with the current state of the economy, this provision is a step in the right direction.
The FICO model has been redesigned to take a more comprehensive overview of a profile to derive a score, so, for example, if you have just one account that goes to collections, it should count less if everything else looks good. The new formula also favors a mix of healthy accounts such as credit cards, car, personal and student loans, so maintaining a diverse credit portfolio should help an individual increase his or her score.
There are, however, two changes that will bring down an individual’s score. Both stem from an industry-wide effort to control risk, which, in this case, has to do with the amount of credit you’re not using. These days, more lenders are closing cards that aren’t being used. Keeping a card open represents a cost to the lender, since they still send out statements every month, but it also represents risk, since the cardholder could suddenly start borrowing against their limit as times get tight. Closing the card will negatively impact your score, so you may want to contact your lender to discuss their policy.
The other change under FICO 08 is more troubling. As I mentioned earlier, it involves credit card companies attempting to decrease their exposure to risk by lowering the credit limits of their clients. Let’s say you had a credit limit of $5,000 dollars and a balance of $1,000 – you’re using 20% of your available credit. But if your lender reduces your credit limit to $2,500, without making another charge, you’d suddenly be using 40% of your available credit, and your credit score would come down. It’s recommended that you use no more than 30% of your credit limit at any time, which could help you avoid being perceived as a risky client by your lenders. If your lender reduces your credit limit, you can call them to ask for an explanation and contest their decision.
Finally, Fair Isaac made adjustments to its piggybacking provision. Piggybacking occurs when a credit cardholder authorizes an additional user on his or her account, specifically so that person can benefit from the cardholder’s good credit standing. While this practice has helped millions of college students and spouses establish their credit history, some disreputable organizations recently began to take piggybacking to extremes. FICO has amended piggybacking to allow spouses and children to improve their credit profile as authorized users, but have banned the inclusion of strangers.
As always, you should review your credit report for accuracy each year. For information on how to receive copies of your report, visit annualcreditreport.com. For those who are interested in receiving a complimentary credit score, you can visit Credit Karma.com.
For more information, or to speak with a certified credit counselor please contact Cambridge Credit Counseling at 800-897-2200 or www.cambridgecredit.org.