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Tens of millions of Americans could soon have substantially more borrowing power, thanks to a groundbreaking change at the country’s most prominent credit scoring company.
The Fair Isaac Corporation, better known as FICO, is the leading provider of credit scores in America. FICO just announced changes in the way their scoring model weighs various factors that contribute to your score. That’s going to have a profound impact because FICO scores are used in 90% of all lending decisions.
How credit scores are ultimately calculated is a trade secret, but FICO sometimes publicly reveals aspects of its formula and methodology. That’s somewhat rare, which is why the recent announcement of a possible change in the FICO scoring model headlines across the nation. The shift in approach is expected to trigger considerable easing of credit restrictions for consumers who have had difficulty repaying some of their debts – particularly in two specific situations or categories.
Why the Announcement is a Big Deal
New research from The Urban Institute confirms that a disturbingly large portion of the population -1 in 3 Americans – are saddled with debt that went into default and was handed over to a collection agency.
One of the causes for the trend is that health care costs are skyrocketing during a time when many Americans are getting older (the “baby boomer” population) and need more healthcare.
Now that FICO is ready to take a closer look at that kind of debt, significant improvement in the credit scores and borrowing capability of millions could take place over the coming months. That is especially true for those who have debt now in collection or who are repaying major medical expenses.
Two Primary Changes
The new scoring model is called FICO Score 9. The first major change in the FICO scoring model deals with past due payments. If you were past due on a payment obligation, but did finally repay it in full – or if you reached a legal settlement with a collection agency – FICO won’t penalize you as was done in the past. Before this change in policy your credit would continue to reflect past-due debts even after you repaid the debt. That could hurt your ability to borrow as much as having a foreclosure or bankruptcy on your record might.
The second major change relates to unpaid medical bills that are in collections or with a credit agency that you are working with to make payments on. Medical debt is the number one cause for bankruptcies because consumers deplete their savings and open up credit cards to cover those bills. From now on, medical debt won’t weigh as heavily on your overall credit score.
Another change worth mentioning deals with consumers with limited or no credit history. The new scoring model uses new techniques to better help them assess the risk of consumers with limited credit histories.
How Long Will it Take?
As with most issues related to your credit profile, it will not happen overnight. FICO expects to start sharing these newly revised credit score formulas with credit bureaus soon, however, and lenders should start receiving them in fall of 2014.
Each lender will individually need to decide how or if they want to apply the new scoring model. Also, despite the fact that FICO is viewing your medical related collection debts differently and not factoring those into your score, they will most likely still be viewable by anyone who has access to your credit files. That kind of credit file information is typically stored for seven years or more.
How to Improve Your Credit Score
While these changes focus on areas of your credit that will not be weighted as heavily when calculating your FICO score, there are other factors that have a tremendous amount of influence.
- One of the biggest contributors to your score is how timely you are about paying your bills. Pay them on time – or even a few days early – and that can drastically strengthen your credit and your score.
- Conversely, if you miss a payment – even by a day – it can hurt your score and also trigger fees and interest rate increases that can make it tougher to repay the total of what you owe.
- Another area that makes up a large portion of your credit score is called “credit utilization.” Your credit utilization is the portion of your total available credit that you borrow against. There is a direct correlation to one’s credit score and their utilization. Check out this infographic for a better understanding or this blog post for an example of one person raised their score within a few weeks by lowering their utilization.