New FICO Model to Change How Credit Scores Are Calculated
Credit Scores Have Gotten Almost Too Good
The impetus behind the new scoring system changes is the fact that the economic picture in this country has changed since the end of the Great Recession. In general, the creditworthiness of borrowers has improved. Lenders are extending credit at the highest rate since the end of the financial crisis and consumers are taking advantage of this to pile on debt to near-record levels.
As a result, lenders are exposed to the possibility that they can face numerous defaults in the event of a future recession. The amount of loans and debt that are currently open presents a possibility that loan default can sink a bank's balance sheet and cause a rerun of the distress that financial institutions faced one decade ago.
Now, banks want to know that consumers have the ability to be able to pay off all of their debts, and they want a window into the consumer's overall debt picture before they extend credit. As a result, Fair Isaac is incorporating changes into the FICO scoring model. The latest release of the FICO model is trying to separate the stronger borrowers from the weaker ones. If your credit is already strong and you have manageable debt levels, you will likely see your credit score go up as a result.
Those with Shaky Credit May See Their Scores Drop Further
Where the new FICO system will really have an impact is on borrowers who have high debt loads. Currently, the FICO score model looks at a monthly snapshot in time of your debt picture. Now, the FICO score will broaden its look over a larger period of time. In addition, the new score will also look at the types of debt that one has in reaching its score calculation. For example, if you have a riskier type of unsecured loan like a personal loan, it will count against you more than a more conventional type of loan like a mortgage or car loan.
Further, if you are behind on your loan payments or have fallen behind in the past, you will also be more likely to see your score drop. You should count on the new FICO score hitting you harder for things that would have had less of an impact under the current system. Credit scores have gotten more consumer-friendly in recent years and the result has been an overall improvement in credit score. However, this somewhat distorts things for lenders as not everyone is as good in reality as they look on paper. Credit reports in general have become watered down and more consumers end up have their scores inflated whether artificially or otherwise.
These changes will affect borrowers who are seeking credit from those institutions that will use the new FICO system. There are several different FICO credit score methodologies and not all banks and lenders will transition to the newer system. In addition, FICO is not the only scoring system that lenders use. The credit unions themselves promote an alternate scoring methodology called VantageScore that is also used by lenders.
Those who are on the bubble for qualifying for credit under the old system will likely be the most impacted by the future FICO tests. If you believe that you are among the class that could see your scores affected for the worse and you need to obtain a loan, it is best to do so now before the impact of the changes are felt. Nonetheless, the most important thing that you can do is to manage your debt load and continue to make timely payments since there is no substitute for that.
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