This summer, the Fair Isaac Corporation will implement new versions of its FICO scores. Millions of consumers could feel the impact. It’s estimated that 40 million Americans will see a drop in their FICO scores.
Wait a minute. Does this mean that FICO scores could fall just because the method for calculating them is being changed? Unfortunately, that’s what is going to happen.
In this post, we’ll analyze the changes and understand the impact that they could have. We’ll also discuss how you could lessen the harmful effects of the new rules on your score.
But before we begin, let’s get a basic understanding of FICO scores.
What is FICO Score?
FICO scores are based on the credit reports issued by the credit bureaus. Equifax, Experian, and TransUnion, which are the biggest bureaus, collect your financial information from various sources. The data that they track includes your:
- Payment history: Do you pay your credit card company by the due date? Are your mortgage payments made in time? Timely payments increase FICO scores. Delays pull them down.
- Amounts owed: Taking on excess debt can lower FICO scores. It’s better to maintain the amount you borrow within reasonable limits.
- Length of credit history: If you have a good repayment record over an extended period, it will result in a higher FICO score.
- Types of credit used: A mix of credit accounts can result in higher FICO scores. So, an individual with credit card debt, a mortgage, a car loan, and a student loan is better off. People who borrow only from a single source could have a lower score.
- New credit: If you suddenly acquire several new credit cards, your FICO score could take a hit. Applying for several sources of credit simultaneously will reduce your score.
Here’s an illustration that summarizes the components that make up a FICO score:
FICO score factors
How do lenders interpret FICO scores? What’s a good score and what isn’t? This information tabulated from Experian will give you an idea:
Range of FICO scores — what your score signifies
|FICO score range||How lenders view this score|
Now let’s move on to the changes that the Fair Isaac Corporation is planning to implement.
What Is Changing in FICO Scores?
Before we address the issue of what’s changing in the FICO scoring model, it’s essential to understand why the changes are being made.
Over the last decade, average FICO scores have been climbing sharply:
Average FICO score
What’s Behind The Increase in Average FICO Scores?
The American economy has been expanding for over 10 years. This is the longest expansion in history. Unemployment is at a 50-year low. Consequently, consumers have more money and are finding it easier to repay the loans they have taken.
But that could be about to change.
David Shellenberger, vice president of scores and predictive analytics at FICO, explains, “There are some lenders that see there are problems on the horizon in terms of consumer performance…. We definitely are finding pockets of greater risk.”
So, how does FICO plan to tackle the “greater risk” that it foresees? It’s replacing the existing version of its credit score — Fico 9 — with Fico 10 and Fico 10 T. These new versions will give greater importance to personal loans. An individual who consolidates debt into a personal loan and then goes on to accumulate more debt can expect to see a decrease in his FICO score.
What Are The Other Changes?
FICO 10 T will take “trended data” into account. This version of the FICO score will analyze an individual’s credit information over the last 24 months and use these details to predict future behavior. So if somebody has been paying off debt over the last few months, he could expect an improvement in his score. But if you’ve been accumulating more debt in the recent past, expect a decline in your score.
The other changes that the new versions will have are:
- If you delay payments to lenders, the impact on your credit score will be more significant than it was in the past.
- Similarly, borrowing more will result in a greater fall in your score.
- Taking a personal could drag your score down.
- If you already have a score of 680 or more, and you continue your good credit behavior, your score could rise at a greater pace.
- You could be penalized for utilizing a higher proportion of your credit limit.
How Could This Impact You?
If you have a good FICO score, the implementation of the changes could see it improve further. However, if your score is in the lower range, it could decline. If this happens, the repercussions could be severe. These could include:
Your loan application may not be approved
Most lenders take credit scores into account before approving requests for loans. A lower score could jeopardize your chances of getting an approval.
Your cost of borrowing may go up
Financial institutions often decide on a lending rate based on your credit score. For example, credit card interest rates currently vary from 16.56% to 23.68%. A lower credit score could mean that your credit card will attract an interest rate that is at the higher end of the band.
Getting a job could be more difficult
Many companies take the precaution of checking a prospective employee’s credit history. Why do they do this? An individual’s credit report may reveal that he has a habit of making late payments or that he carries excessive debt. Employers could think that a person with a poor credit record would be more likely to commit fraud.
You could pay more for auto insurance
A lower credit score may mean paying more for car insurance. This chart from Insure.com tells you exactly how much more.
If your credit score falls, you could pay more for auto insurance
It could be more difficult to rent an apartment or a house
Landlords check the credit scores of people who show an interest in renting their properties. A poor score could disqualify you.
How Can You Mitigate the Changes in FICO Scores?
If you’re worried about the changes that FICO is implementing, you needn’t be. We’ll tell you how to maintain your credit score and even improve it.
Here’s what you can do:
1. Don’t fall behind on your loan payments: Remember that your payment history accounts for 35% of your FICO score. You must do your best to pay your bank or the financial institution that you have borrowed from, on time. If you have a small business loan from Camino Financial, ensure that you meet your repayment commitments. That will increase your score fast!
3. Don’t use your credit limit to the hilt: Maxing out your credit cards isn’t a good idea. It can result in a decline in your credit score. Ideally, you should restrict your utilization to about 30% of your credit limit.
4. Understand the difference between hard and soft credit inquiries: A soft inquiry doesn’t affect your credit score. Examples of soft inquiries are when an employer checks your credit or when you check it yourself using tools like Credit Karma.
However, if you apply for a new credit card or an auto loan, it could lead to a hard inquiry. Too many of these in a short period can pull your score down. If you’re permitting someone to check your credit score, verify whether it will result in a hard pull or a soft pull.
5. Limit the amount you borrow: Over-borrowing can reduce your credit score. Try and minimize the loans you take. Remember that multiple personal loans can harm your score.
6. Don’t forget that the length of your credit history is important: If there’s an old credit card that you aren’t using anymore, you could be tempted to cancel it. That can be a mistake. Old accounts help your credit score, so keep them active.
What if your credit score is already damaged and you need a small business loan? Camino Financial can help. Our motto is “No business left behind,” and our loan requirements underwriting rules reflect this philosophy. You don’t need a minimum FICO score to apply for one of our business loans. Even those without a credit history can apply.
There are other benefits, as well. If you apply for a loan to Camino Financial, it won’t result in a hard pull. So your credit score will remain unaffected. Additionally, we provide collateral-free loans. Borrowers can obtain funds from us without having to put up any security. In other words, you have nothing to lose by trying us!
The Bottom Line
Don’t worry too much about the changes that FICO is making. Focus on managing your debt responsibly. This will help you to maintain your credit score. Your score could even go up under the new rules.
If you require funds for your company, apply for a small business loan to Camino Financial. Our loan specialists will be happy to guide you through the application process. We are loyal to our motto and we want to hear from you!
Was this article helpful? If you want to find out more about how credit scores work, we invite you to read: