New FICO Credit Scores Will Affect Millions of Americans

FICO, provider of the most widely used credit score[1] in the U.S., is making big changes to its credit scoring system that will take effect this summer. The company says[2] these changes will likely affect 110 million Americans, whose credit scores will either go up or down. Some 80 million are likely to see significant changes of 20 points or more.

Here’s what you need to know.

Why is FICO making these changes?

One reason is that credit scores for U.S. consumers have been creeping up since 2009, reaching an average[3] of 706. The higher scores reflect some combination of improved creditworthiness as the economy has strengthened, changes to FICO’s scoring over the past several years, and the effects of a settlement[4] between several states and the nation’s three biggest credit reporting companies, TransUnion, Equifax, and Experian. As a result of that settlement, the credit reporting companies expunged negative credit items from millions of Americans’ reports. FICO is adamant that the improving scores reflect improving creditworthiness, not artificial score inflation, but at least some lenders are not so sure. They’re also concerned about what will happen if the economy weakens.

Using its new FICO Score 10 T, lenders will be able to make better lending decisions, the company said in a press release. This could result in as much as a 10 percent reduction in defaults on new credit cards, as much as a 9 percent reduction in defaults on new auto loans, and as much as a 17 percent reduction in defaults on new mortgages, the company claims. Lenders will have the option to retain the previous FICO score, but it seems likely they’ll switch over to the new one.

Will my credit score go up or down?

It depends. According to[5] the The Wall Street Journal, The new score will take into account two years of debt levels rather than just the previous month. That means if, say, every year you run up a lot of credit card debt buying presents at holiday time, but then you quickly pay off that debt in the new year, the negative effect on your credit score will be smaller than in the past. On the other hand, if your debt level has been increasing over time, you’ll see a bigger hit to your credit score than in the past. Missed payments will also weigh more heavily than they did before. On the other hand, if it’s been more than a year since you last missed a payment, you may wind up with a higher score than you would have had before. 

Even if you’re paying on time, if you previously always paid off your credit cards but now carry a balance from month to month, that will lower your credit score more than it would have previously. And one more thing: If you took out a personal loan to pay off or pay down credit card debt but then ran up the balances on your credit cards again, your credit score will likely go down more than it would have before.

What should I do about all this?

For the most part, you should follow the same advice you’ve always heard about managing debt, especially credit card debt[6]. But there are a few extra caveats. First, if you previously had a lot of debt and/or were late making payments but you’ve recently cleaned up your act — be patient. It may take a little longer for your new good behavior to be reflected in your credit score.

Next, it’s even more important than it was before to make credit card and other loan payments on time. If you haven’t already done so, set up automatic payments so that at least the minimum payment will be covered. You need to pay more than the minimum payment to pay down or pay off your credit card debt, but at least having the minimum payment automatically deducted for you will prevent you from getting dinged with late payment fees, and it will keep late payments from lowering your credit score.

You may be considering taking out a personal loan to consolidate some or all of your credit card debt. That can be a great idea because you’ll wind up with a lower interest rate, which means you can get out of debt faster. However, if you do choose this option, make sure you don’t start running up your credit card balances again. Otherwise, not only will your credit score suffer badly, you’ll be even deeper in debt than you were before.

The new FICO score pays close attention to how your debt is trending over time and so should you. If your total debt is shrinking and has been for the past several months, then it will look to FICO like you’re on the right track and your credit score should reflect that. Not only that, you actually will be on the right track. And you can look forward to a day when you’ll be debt free.

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