Credit Score Calcualtion Changes

Changes to FICO ’08!

In the fall of 2008, the way consumer credit scores were calculated was to change.  But soon after the proposed changes, disputes arose which delayed the shift.  According the Liz Weston from MSN Money, “TransUnion will offer the new score to lenders starting in late January 2009, with Equifax introducing it in the spring.”

Fair Isaac, the creator of FICO, says the new score will do a better job of predicting defaults than the classic FICO, which is used in more than 75% of mortgage lending decisions and by 90% of the largest U.S. lenders.  But FICO ’08 was even more sensitive that the classic FICO to how much of your available credit you are using.  If your credit card issuer slashes your credit limit – which is increasing likely these days – you could see your scores plunge, regardless of whether you carry a balance.

Another hazard for consumers: The new scoring formula responds more negatively if consumers have few open, active accounts.  Because more credit card issuers are shutting down unused and unprofitable accounts, which boosts the chances of damage to your scores.

3 Victories for Consumers

Not all the news is bad.  FICO ’08 offers some definite improvements for consumers in several areas, including:

• Collections.  The new formula ignores small collection accounts in which the original debt was less than $100.  This is a big victory for consumers and one Liz Nelson has advocated for years, because niggling little debts – created by unpaid library fines, forgotten parking tickets or small medical bills that slipped through the insurance cracks, had an outsize impact on people’s scores.
• Credit missteps.  Fair Isaac says the new version is less punishing to those who have had a serious credit setback, such as a charge-off or repossession, as long as their other active credit accounts are all in good standing.
• Authorized users.  Fair Isaac initially said FICO ’08 would combat potential fraud by ignoring any “authorized-user” accounts in a borrower’s credit report.  After a big consumer outcry and potential credit fairness issues, Fair Isaac backed off and decided some authorized-user information would be included.

Ways to protect your score:

Credit Utilization is one of the biggest hazards for consumers.  As issuers slash credit limits, the gap narrows between customers’ balances and their limits, which is generally bad for their credit scores.  How bad is tough to predict.  A limit reduction on a single account won’t necessarily trash your credit.  Because FICO scores assess a lot of data, the effect of a single factor like a credit limit reduction will depend on what other data is on the credit report and how much the line is reduced.

It’s fair to say, though, that big reductions in credit limits, and reductions affecting more than one account, are not going to be good for your scores.  Credit card expert Ben Woolsey of CreditCards.com noted that issuers’ credit limit reductions so far – and the promise of more to come – are “clearly a hazard” to consumers’ scores.

Still, Fair Isaac defends the accuracy of its formulas.  Watts said the company’s research has so far found the credit limit reductions have affected “a relatively small population and those line reductions have been a relatively small amount for a sizable part of that population.”  At the same time, he said, a “notable number” of consumers have reduced their use of revolving credit such as credit cards, which is helping to minimize any impact to their FICO scores from credit limit reductions. 

Watch those balances.  The less credit lines that you use, the better, even if you pay your balances every month.  The credit bureaus don’t distinguish between balances you pay off and those you carry month to month; the balances that’s reported to the bureaus is typically the one that shows on your most recent monthly statement. 

If you are in the habit of using a big portion of your credit limit because you travel on business or are chasing credit card rewards, consider asking for a higher limit or using more than one card.  Ideally, you would use no more than 30% of your available limit at any time during the month; less than 10% is even better.  If your credit card issuer slashes your credit limit, try to get the decision rescinded.  If that’s not possible, use the card less and move at least a portion of your balance to other cards or to an installment loan.  For credit scoring purposes, it’s better to have small balances on a number of cards than a big balance on a single account.

Don’t close accounts.  Fair Isaac has made it clear that closing accounts can never help a classic FICO score and may hurt it.  With FICO ’08, that’s even truer.  You get more points for having open accounts in good standing; conversely, having a higher proportion of closed accounts can hurt you more.

Consider an installment loan.  There are two main types of credit: revolving accounts that allow you to build up and pay down balances, and installment loans that typically have fixed payments that require you to pay down your balance over time.  Credit cards and lines of credit are examples or revolving accounts, while auto loans and mortgages are considered installment loans.  The FICO formula has always rewarded folks who had and successfully managed both types, which is why getting an installment loan was often recommended as a way for people with troubled credit to rehabilitate their scores.  The new scoring formula is even more sensitive to the mix of credit types people have and use.  In the past, people were able to get and keep very high scores using only credit cards; it’s not clear if that will still be true under FICO ’08.

Source:    www.myfico.com
http://articles.moneycentral.msn.com/Banking/CreditCardSmarts/new-risks-to-credit-scores.aspx?page=all