Huge Changes Could be Coming to Your Credit Score
Dear Rich Lifer,
Your three-digit FICO score can affect many parts of your life.
Lenders use it to decide whether or not to give you loans or increase credit lines …
Landlords use it to decide whether or not to rent you apartments, offices, and other properties …
Plus, potential employers might use it to decide whether or not to give you a job.
And now, with new changes coming to the FICO system by the end of this year, your score might go up or down by 20 points … without any changes in your own financial behavior at all!
Before I explain what that is, let me first say that I have been an outspoken critic of the FICO credit score system for years now.
I don’t think it’s transparent enough.
I hate that you can’t even get your own score for free (unless your bank or financial institution provides it to you as an added service).
And I don’t think it’s always a true reflection of someone’s risk to a lender.
Consider This Scenario
Let’s say you have a person who:
- Rents an apartment for much of their adult life while working hard and saving religiously.
- Paid cash for a car ten years ago and still drives it today.
- Doesn’t have a mortgage.
- Has just one rewards credit card and pays off the balance in full every month
- Frequently moves money from one bank to another based on whichever one is paying the highest interest rates.
These are all financially-savvy moves, right?
To me they are!
But as far as the FICO system is concerned, a person needs a long credit history and a “healthy mix” of loans. Opening and closing bank accounts also causes credit report pulls, which are red flags in the system.
So someone doing the things I just described would probably get penalized.
Meanwhile, consider the fact that having lots of credit cards or a bunch of loans very often INCREASES your credit score.
Which brings me to the two biggest changes to the new version of the FICO score, which is being called FICO 10.
FICO Challenge One
The FICO system basically rewards people who borrow frequently, pay their interest on time, and keep their mouths shut.
Under the new FICO 10 (and a sister version called 10T), that’s still true.
In fact, people with already-good credit scores, who pay off their credit card balances in full and on time every billing period, will probably see their FICO numbers go even higher.
Fair Isaac Corp., the company behind FICO scores, says roughly 40 million Americans will see their FICO scores go up by 20 points when this new system goes into place.
That’s the good news.
The bad news is that the same number of Americans will see their scores automatically drop by 20 points.
The biggest reason?
The FICO system will now take a closer look at how personal loans fit into someone’s financial picture.
“Previous FICO score models were not anchored as much to personal loan data, yet since 2015 the number of personal loans has risen 42%, making personal loans the fastest-growing category of debt in the country. Currently, there is upwards of $156 billion in outstanding personal loan debt.”
Many Americans have been using personal loans as a way to consolidate and/or pay down credit card debt.
That maneuver can make sense, especially if the interest rate is much lower.
It can also end up being a band-aid if other borrowing habits aren’t changed – namely, if someone just starts racking up more credit card debt all over again.
Enter the other big FICO score adjustment…
FICO Challenge Two
Rather than simply looking at a moment in time, FICO 10 will consider a rolling 24-month period to gauge longer-term trends in someone’s borrowing activity.
Overall, I consider both of these changes to be good ones – for both lenders and borrowers.
At the same time, my bigger criticisms remain.
The entire idea of FICO scores just encourages a culture of perpetual debt.
Big banks — the companies who drive the credit score industry — want you to be a frequent and responsible borrower for the rest of your life.
So if you happen to see your score jump 20 points or more as these new changes go into effect, great, you deserve it!
If you see your score drop sharply, use it as a wakeup call to change your ways!
And in either case, your ultimate goal should always be saving and investing to reach the point where credit scores no longer impact your life much at all.
To a richer life,