Practical money matters by Jason Alderman
CREDIT SCORING has evolved over the last three decades and this fall, FICO made one more important change. Borrowers who have struggled with medical debt and those with a limited credit history might see better FICO numbers in the future. Even if these situations don’t apply to you, understanding how credit scoring is changing can help you better manage your credit over time.
FICO Score 9, rolled out last fall, is described as a more “nuanced” version of the original FICO Score that the leading credit scoring company introduced in 1989. It is offered by three major credit bureaus – Equifax (equifax.com), Experian (experian.com) and TransUnion. (transunion.com). It now bypasses collection agency accounts and weighs medical debt differently than non-medical debt on a person’s credit record. Borrowers with a median score of 711 whose only negative credit data comes from medical collections will see their credit score go up 25 points under the new system.
As for consumers with limited credit histories – what the industry calls “thin files” – FICO says the new system will better determine the ability of someone in that situation to repay a debt.
What doesn’t FICO 9 address? At this point, the latest credit-scoring model really doesn’t loosen or change requirements for mortgage and refinancing opportunities. Even so, there are many things ordinary borrowers can do to improve their credit scores and overall financial health over time.
The first step is for borrowers to review each of their credit reports once a year. Credit reports and credit scores are two different things. Consider credit scores are a three-digit summary of creditworthiness; credit reports are the detailed record of a borrower’s credit history. Consumers can view each of their credit reports from Equifax, Experian and TransUnion once a year for free (annualcreditreport.com). Stagger receipt of each agency’s credit reports throughout the year to weed out any inconsistencies, inaccuracies, or worse, indications of fraudulent credit applications or identity theft.
Borrowers are seeing something else that’s new – some lenders are making the credit scores they apply to existing borrowers available for free. A few major lenders have taken part in the industry-only FICO Score Open Access Program, which lets current customers see the exact credit scoring data applied to them at no charge. FICO’s site doesn’t offer the names of participating lenders, but a customer should ask their lender if they are offering free scores through that program.
Consumers should know how credit scores are compiled. FICO uses five key ingredients:
Payment history (35%)
Amounts owed (30%)
Length of credit history (15%)
New credit (10%)
Type of credit used (10%)
Visit myfico.com for a list of tips for borrowers to improve their scores. Base FICO scores have a 300 to 850 score range, and though FICO doesn’t release what it considers good or bad scores, borrowers with excellent credit typically have scores in the mid-700s and up.
There are ways to preserve and raise existing credit scores. It might be wise for borrowers to ask if they can increase the credit limit on individual accounts while paying down existing balances on those accounts. Smart borrowers generally keep their outstanding balances at 30 per cent or less of their available credit limit.
Bottom line: Smart credit management starts with an understanding of one’s credit reports and credit scores.
Jason Alderman directs Visa’s Practical Money Skills For Life financial education programs. Follow him on Twitter at twitter.com/PracticalMoney. His articles are intended to provide general information and should not be considered legal, tax or financial advice. Always consult a tax or financial adviser for information on how the law applies to your individual financial circumstances.