Anyone who uses a computer these days won’t be too surprised to see an update notification pop up on the screen. While you’re reading your email or playing Scrabble, irritating little boxes will jump in front of you declaring your virus protection out of date or offering a new, improved version of whatever app you’re using. It’s a part of modern life.
Did you know that your credit scoring structure also gets updates? Every few years, the criteria and algorithms for measuring credit scores gets a tuneup. We as credit holders get no say in the matter, and this is not the kind of update you can click away.
Coming up this year, probably by the end of the summer, the FICO 10 Score will be in place. This is the first time the score has changed since the FICO 9 Score came out in 2014. So, when you sit down by the pool to check your score on your phone in August, the number may look a little different. We want you to be ready.
Your Credit Score in a Digital Age
For centuries, our credit history was based on a mix of personal reputation, hearsay and observed habits. Honestly, today’s credit score is based on the same ideas in a modern, digital way in a highly populated and complex world. Your history of loans, use of credit cards and punctuality about repayment all factor in.
The new system, FICO 10, will use many of the same base criteria, but sharpened and more sensitive. The traditional five factors – amounts owed, payment history, age of credit history, new accounts and credit mix – will form the base. But delinquency and delayed payments will hurt your credit score all the more, and quicker than they used to.
Think of your funny aunt who used to use “rubber checks” for Christmas gifts and then try to back-fill her accounts quickly before they bounced. In a digital world, that kind of “strategy” doesn’t make sense anymore because the data is processed so quickly. Now credit scores are more quickly assessed and more sensitive as well.
Change the Scorecard, Change the Score
One of the most obvious effects of the FICO 10 update is a change in credit score, which will probably look like this:
- 40 million people will see a 20 point rise
- 40 million people will see a 20 point decrease
- 110 million will see a change – up or down – of less than 20 points
Do the math, and that’s about two-thirds of Americans finding a different score waiting for them. What starts as a relatively small change in detail will reverberate through the country, and affect everything from personal loans to home-buying.
There are several factors involved in this slight but deep shift. Let’s look at a few.
Credit Score Inflation
Inflation, whether of a balloon or a market, makes things larger and less stable and strong. Credit scores have gone up in recent years, but it essentially means less. As part of the National Consumer Assistance Plan, the three gigantic firms involved in credit scoring recently removed tax liens and judgments from scoring criteria.
Then the concern becomes whether the credit scores, like inflated dollars, really mean as much. If the whole country, resulting from this kind of change, has an average credit score of 706 (which was the case in 2019), how much does a high score really tell lenders?
This inflation – and restoring accuracy to the credit score process – was part of the impetus behind FICO 10.
The metrics have also changed with the addition of trended data. Sometimes called time-series data, this metric shows how you’ve interacted with your credit accounts over the past two years, showing the “trend” of your personal financial culture. This can give lenders a more accurate assessment of your credit behavior.
Trended data includes your balances, minimum payment requirements and how much you paid on credit card statements for 24 months. The major distinction the credit score model can make here is between those who pay off their balance every month and those who carry over – ”revolve” – a balance and pay the minimum. Those who pay it off each month would have a higher credit score.
The FICO credit score change then no longer involves the somewhat superficial record of bills and payments, but a three-dimensional analysis of financial behavior.
The Willy Wonka Factor
Keep in mind, too, that no one knows entirely what goes into calculating your credit score. It’s like the infamous Chocolate Factory in which a mysterious man makes great candy, but no one quite knows how it gets done.
This privacy is important, to keep people from hot-wiring the system, but it’s something we should consider. The credit tips we know are from reverse engineering, based on what appear to be trends in the results.
A Few Tips (Not Hacks) about Credit Scores
The well-worn advice for keeping and improving your credit still works even after the FICO credit score change: pay them off on time, don’t max out, don’t open too many cards. Raising your score is, for the most part, a matter of being wise with your money over a long period of time, not hacking the process. But there are some slight changes to keep in mind for FICO 10.
There’s no shortage of ads on TV and the internet for consolidation loans – putting all your credit cards on one loan with an “easy” monthly payment. This is usually a smart idea: You’ll pay far less in interest on a personal loan than you will on the money you owe on plastic.
However, if while you are paying this “easy” payment, you start running up the balance on your credit cards again, FICO 10 will be even more sensitive. Robbing Peter to pay Paul in this sense is a no-no that is much more likely to hurt your credit under FICO 10 than it did in the past.
Just because you have a $20,000 limit doesn’t mean you should buy that $19,000 swimming pool! Your credit utilization – how much you have available versus how much you use – also affects your score.
The FICO 10 score is expected to be more sensitive to your utilization habits, so you have to hit the sweet spot here. Revolving a high balance is the worst, but maintaining a zero balance isn’t the best. The A-team of credit users with a score over 800 use about 7% of their available credit on average.
Finance, like the rest of life, is not static. Even the pillars of finance like credit scores occasionally get refurbished. Keep yourself informed and flexible when handling your plan, particularly so you’re ready before the landscape changes. Set your appointment with your wealth advisor today to see how credit scores and other factors affect your personal financial strategy.