Almost 200 million Americans are expected to see their credit score change in the next year due to modifications to how these credit scores are calculated—meaning your score might change even if your debt repayment habits stay the same.
This change is because FICO, the analytics company that attaches scores to the creditworthiness of almost every American adult, is changing its flagship algorithm for determining your credit score. Announced January 23, 2020, FICO Score 10 launches this summer.
While there is no reason to panic, you should definitely be aware of how the updates could impact your score, your creditworthiness, and your small business.
Your Credit Score Might Fall in 2020
FICO says that the changes will have an impact on many American consumers, although the company says the actual numerical change won’t be overwhelming.
In total, FICO predicts that approximately 110 million consumers in the United States will see their credit score change less than 20 points due to the new system. Less fortunately, FICO says about 80 million people will see their score change 20 points or more in either direction.
Essentially, FICO is taking a slightly different approach to calculating scores by, among other factors, looking at a longer credit repayment history and weighing categories of debt in different ways.
What is a FICO Score?
FICO, formerly the Fair Isaac Corporation, establishes the creditworthiness of an individual and assigns a numerical “score,” typically between 300 and 850, to that person. Love it or hate it, this FICO credit score is the lending industry standard for credit-related decisions.
FICO calculates its scores from information pulled from the 3 major US credit bureaus: Experian, TransUnion, and Equifax. These bureaus, in turn, gather information from lenders like credit card companies, student loan lenders, and banks.
What Is A Good Credit Score?
A score above 670 is generally considered “good,” and a score above 800 is considered “exceptional.” Only 21% of Americans have exceptional scores, while another 46% have scores above 670 but under 800.
Your personal credit score can have a significant impact on your ability to get a business loan, too. Banks typically want applicants to have credit scores above 800, but there are other lending alternatives.
How FICO Changes Over Time
Not only does your credit score fluctuate over the years based on how you engage with debt, but how FICO, which was founded back in 1958, determines scores changes as well.
Every few years, FICO alters its algorithms. The company says that the changes are necessary to better reflect consumer trends and provide the best predictive data for lenders.
The current FICO suite, FICO Score 9, was launched in 2014. This score included new elements like rental history and changed how medical debt impacted scores. It replaced FICO Score 8, which was released in 2009 soon after the global financial crisis.
Credit scores get even more complicated—FICO Score 8 is still incredibly popular, even though FICO Score 9 is several years old. And some lenders use VantageScore, a rival to FICO, to determine scores.
What is FICO Score 10?
While the FICO Score 9 revisions were largely seen as helpful to consumers, in many respects, FICO Score 10 swings the other way, toward lenders.
With fears of a recession looming, FICO said that they were trying to examine new pockets of risk for lenders. FICO 10 will look back at a longer period of your lending history and examine how your debt balance changed over time. Additionally, some types of debt will be seen as riskier, like personal loans, which will hurt scores.
“Clients value the dependability and industry-leading predictive power of the FICO Score,” Jim Wehmann, the executive vice president for scores at FICO, said in a statement. “FICO is a cornerstone for consumer lending decisions. We continuously innovate using the latest, most robust data, while maintaining consistency with previous models to ensure backward compatibility and minimize operational changes required to adopt a new score.”
How Your Score Could Be Impacted
Unfortunately, if your credit score is already low, it might be driven lower by the FICO 10 changes.
While the major deciding factors for your credit score are not changing dramatically, you will be scored at least slightly differently due to FICO 10. And if you’ve struggled with late payments or seen your debt mount upward over the past 24 months, you might be hit the hardest.
“There are some lenders that see there are problems on the horizon in terms of consumer performance,” David Shellenberger, a FICO executive, told the Wall Street Journal, adding, “We definitely are finding pockets of greater risk.”
Americans are piling up consumer debt. At the end of 2019, US household debt hit $13.95 trillion, according to the Federal Reserve Bank of New York. Over 5 consecutive years of increases, household debt is now higher than the previous $12.68 trillion peak it reached directly before the 2008 Financial Crisis. Probably because of this trend, FICO 10 takes a harder look at how you pay off your credit cards over time.
FICO 10 puts a greater emphasis on your credit utilization ratio, meaning the amount of credit you are using compared to the credit available to you. This is good news if you pay off your credit card balances every month, but your score will likely trend downward if you are close to maxed out on your cards.
Another change is that FICO will take into account how your credit card balances have changed over time. If your balances have been high for months, i.e., you’re just making the minimum payment every month, your scores might drop.
Examining a Longer Period
For the first time, the new FICO Score 10 considers “trended data,” sometimes known as time-series data. Trended data looks at how the information on your credit reports changed over the past 24 months. If you’ve paid off debts every month, your score will likely benefit from the change. If you usually carry a balance and/or add to it, your score might be hit.
“Many lenders want to leverage the most comprehensive data possible to make precise lending decisions,” Wehmann continued. “By offering a score that taps further into trended data, we’re able to give lenders greater flexibility and predictive power, as well as ease of integration.”
If you’ve missed a payment within the past year, this mistake will also drag your score down further in FICO 10 than with earlier systems.
While FICO has always considered credit history, it generally looked at the past few months to a year. The trended data component is supposed to give a more well-rounded prediction to lenders. In fact, FICO predicts FICO Score 10 will reduce defaults on new bank credit card accounts by as much as 10%.
FICO Score 10 will penalize consumers who have taken out personal loans, sometimes called “signature loans.” These types of loans have become increasingly common—you might have some offers in your mailbox right now. Personal loans are typically used to consolidate debt or to pay off credit cards for a lower interest rate.
While the personal loan industry argues that their products can help bolster your credit, FICO is now seeing these as risky because personal loans are unsecured and don’t require collateral.
Technically, a payday or cash advance loan would also be considered a personal loan. However, many payday lenders don’t report these extremely high-interest loans to the credit bureaus, so data about payday loans might not reach FICO.
What Influences Your Score the Most
The factors that impact your credit score the most will stay the same, though.
Your payment history will be the largest influence on your score. In FICO Score 10, payment history will continue to determine 35% of your credit score, making it the most important aspect of your credit report. The guiding wisdom here is that past repayment behavior is the best way to determine your ability to pay off new debts.
FICO looks at both installment debt, like student loans or mortgages, and “revolving” debt, like credit cards. You want to ensure you make your payments on time.
While credit utilization will remain the 2nd most important factor of your score at 30%, how it changes over time will be given more significance than before. Typically, you want to use less than 30% of the total credit available to you.
Smaller factors such as the length of your credit history, the variety of credit available to you, and the number of new credit lines opened recently still have an impact in FICO 10. However, now elements like trended data will be taken into consideration alongside them.
Overall, if your credit habits have been good over the past 2 years, you should see a small increase with FICO 10. If you’ve kept high balances over long periods or missed payments, though, you could see a downward shift.