Forget how much you weigh. If there’s one number that you should keep track of in today’s consumeristic society, it’s your FICO score. A higher score out of 850, the more attractive you look to lenders and vice versa.
Fair Isaac Corporation, the analytics company that puts together your FICO score, recently made changes so that its scoring model can better reflect a consumer’s creditworthiness. This latest version, FICO 9, is the ninth version of the credit scoring model that was first introduced in 1989. One of FICO 9’s goal is to make it easier for consumers impacted by the severe recession to obtain credit.
Two types of people benefit. First, if you fell behind on paying a bill, but have since paid it off or settled the account with a collection agency, FICO will no longer calculate such an occurrence in your score. Second, if you have an unpaid medical bill that is being handled by a collection agency, this will have a reduced impact on your FICO score than before. This change has come about because FICO recognizes that consumers have less control over medical payments that are typically made through insurance companies.
The end result is that some consumers might see their credit score rise by as much as 25 points.
Why FICO Score Matters
Lenders use your FICO score, which could range anywhere from 300 to 850, as input to determine the interest rate you might pay on your home mortgage, car loan or other major consumer purchases. Credit card issuers also use your FICO score to set your terms.
If you are in the market for a mortgage to buy a house, for instance, it’s in your best interest to keep abreast of your FICO score and do whatever it takes to maintain or raise your score. FICO explains if you have a score in the range of 760 to 850, you could get a rate that’s about 1.5 percent lower than the rate someone with a score in the 620 to 639 range would obtain. For example, with a higher credit score you could get a 3.77% rate on a $300,000 mortgage loan and save about $285 a month, which adds up over the life of the loan.
While FICO scores play a significant role in the lending process, keep in mind lenders also use their own metrics to make a decision.
What Goes Into Your FICO Score?
FICO inputs information from the credit reports of three major credit reporting agencies: Equifax, Experian and TransUnion. Each agency uses their own mathematical model to come up with a FICO score for you. FICO’s model mines the data to find patterns to predict future outcomes relating to how likely you are to be a high or low credit risk.
The data that the model uses includes:
1) Your payment history, or whether you have made your payments on time in the past. This makes up as much as 35 percent of your score.
2) Also important is the total amount of money you owe on your credit accounts, which influences up to 30 percent of the score. If you are using a higher percentage of the credit available to you, it could be a sign that you are at risk of missing payments in the future.
3) Another factor the FICO equation considers is how far back your credit history goes. This makes up as much as 15 percent of your FICO score. If you have been using credit responsibly for a long time, it is likely to have a more favorable impact on your credit score.
4) Also playing a role in your score are new credit and the types of credit you use, each of which accounts for 10 percent of your score. So opening a number of new credit accounts within a short span of time could trigger FICO’s risk alerts.
5) Finally, the type of credit used, such as from a retail store or a mortgage lender, will also factor into the calculation.
Past Changes To FICO
FICO has been constantly making changes to its score modeling since the FICO score was introduced to ensure that it more accurately measures the risk of a consumer defaulting as his/her behavior changes. FICO 8, introduced in 2009, made changes that penalized people who used up a higher amount of their credit limit. The model was also more lenient regarding a single late payment, provided you were otherwise prompt on paying your bills. FICO 8 also ignored the impact of small-balance loans – balances less than $100 that went into collection.
While such changes seek to present a more accurate picture of your creditworthiness, they are not necessarily going to have a big impact. This is because lenders have to adopt the changed models and they will only do so after adequate testing. With FICO 8, it took a year or two for lenders to feel comfortable with the change. Housing finance giants Fannie Mae and Freddie Mac, continue to hold on to older versions of FICO.
Given this history, it might take another year or two until you actually feel any real impact on your borrowing power from the changes introduced by FICO 9, which will be available to lenders this fall. As to the impact on your score, if any unpaid debt you have is all medical debt, and other things are equal, you could see your FICO score go up as much as 25 points. Meanwhile, any previous unpaid bills that stayed on your record for seven years even after you paid them will no longer impact your score in the future once you pay them off.
FICO 9 changes also make it easier for lenders to gauge the credit risk associated with those who have a limited credit history, referred to as “thin files.” And the changes made will also make your FICO score more consistent across the three credit bureaus.
Do You Know What Your FICO Score Is?
Higher credit scores means lower interest rates. Pay your bills on time. Don’t max out your credit cards. Keep credit inquiries at a minimum and make inquiries for new loans within a specific time frame. For instance, if you are shopping for a mortgage loan, make rate shopping inquiries with multiple lenders within a one-month timeframe. This way, FICO will see it as a single credit inquiry, rather than multiple inquiries for multiple loans. And finally, let the passage of time help build your credit score.
Government regulations allow you to get a free copy of your credit report from the credit reporting agencies once a year as well. Some credit card companies like Discover are also showing clients their credit scores on their monthly statements for free. It’s not only a good idea to know your credit score, you should also regularly review your credit report for errors.
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