Monday, February 9, 2009

What's up with FICO Credit Scoring Changes

Fair Isaac, the company behind your credit score, will unveil a new version of its FICO credit scoring formula, called FICO 08. (As you guessed it was supposed to be released last year--never name a project after it's release date. That's just asking for delays.) Anyway...

If you not familiar with Fair Isaac and FICO, I am embarrassed for you...just kidding. The FICO is that crazy number that controls your life and tries to give lenders some idea of whether or not you can pay back loans--your credit score. The FICO ranges from 300 to 850. The higher your score the less risk you pose. The number is derived from a complex algorithm of several different inputs based on how you've handled payments in the past.

The new FICO 08 is expected to give lenders a better risk assessment and be fairer to consumers. So here's how Fair Isaac has tried to improve FICO:

Authorized Users: You might be an authorized user on a credit card if the original application was filed using your spouse's name. Previously you could not have the history of these accounts taken into consideration, so some spouse's may end up with a low credit score due to lack of credit history.

Not all Collections are Equal: The new scoring will not just ding you if you've had an account go to collections. Now the size of the collection and the number will be considered. Collections can happen to anyone. Maybe you moved and the bill was not forwarded. Or maybe you've had a spat over a product and the other party sent the bill to collections for spite.

One Bad Apple Doesn't Ruin the Bunch: Now one mistake can't take you down for good. If all other history is good you can still come out with a good rating.

Available Credit is More Important than Ever: As always you want your available credit to be much higher than your used credit. But with some lenders lowering credit limits the margin may be tighter. However, FICO will weigh this heavier than ever. So this puts an end to the debate of whether or not you should close unused cards. Keep them open to keep your available credit high. To avoid having them closed down by the card issuer use them sparingly, but regularly. You might want to set up a reoccurring bill such as a cell phone or video rental account just to keep the card active, yet manageable.

Mix it Up: Also weighed heavier will be the mix of accounts. Only having credit cards will not be viewed favorably. FICO also wants to see some fixed payment accounts like car loans, personal loans and mortgages.

The hope is that the new scoring will help lenders make better decisions and decrease loan defaults. For everyone else it's still best to use credit in moderation and pay your bills on time. And don't forget to review your credit report several times a year. Remember, your credit report is not the same as your credit score. But, by reviewing your report you'll be able to catch errors that can adversely affect your score.

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