Fair Isaac Corporation, the maker of the popular FICO scoring system has changed-up its recipe of how it calculates consumers' credit scores with its new FICO 2008 model. This new scoring model which was originally scheduled to release in 2008 (hence the name) began implementation last week. This is the biggest change to the credit-scoring system since 1989, and is anticipated to affect 40-50% of consumers' credit scores by approximately 20 points.
During a time when lenders are re-evaluating their risk tolerance, Fair Isaac Corporation believes its introduction of FICO 2008 provides a 5-15% improvement to default predictability. The scoring model still uses its familiar 300-850 score range, but contends the new system considers the bigger picture, and better differentiates between consumers with incidental late payments, and those who habitually miss payments.
Transunion adopted FICO 2008 last week, and Equifax anticipates implementation in second quarter 2009.
Here are a few pros and cons to the new scoring system.
The Pro's
Spouses and family members can benefit from being authorized users. The benefit of "inheriting" someone's good credit history by virtue of being an authorized user was recently challenged by Fair Isaac; but after harsh consumer and regulatory backlash, Fair Isaac will allow family members to benefit from authorized user status. Although, there is no way to verify someone's familial relationship, filters have been added to FICO 2008 to better disqualify "piggy-backing" -- a method by which people allow strangers to piggy-back on their good credit by giving them authorized user status on their credit cards for a fee.
Small collections hurt less. Collections under $100 will not hurt credit scores as severely as they did in the past.
Big picture matters more. Previously, a late payment would immediately flush a score down the toilet. Under FICO 2008, an incidental late will not affect the score as much if someone has an overall good pay history (see figure 3).
The Con's
Less credit hurts score. Available credit on revolving accounts will be much heavier weighted. This may negatively affect many consumers as credit card balances rise during our recession, and credit card companies slash consumers' credit limits. Fewer open and active accounts will also negatively impact scores which affects people who don't utilize as much credit.
A healthy mix of accounts is better. Its better for consumers to have a mix of auto, revolving, mortgage, installment, etc. than to have only one type of account like student loans.
Closed or unused accounts hurt score. Paying-off your credit cards? Make sure to keep them active afterwards because closing them or allowing them to go dormant will hurt your score. A great alternative to closing your account is using it only for gas or groceries and paying-off the balance at the end of the month.
Don't let these changes overwhelm you, as tried and true methods of managing credit will always work: Keep balances low relative to your credit limits, keep a good mix of account types, and payoff balances on time and in full. You may not always have the highest FICO on the block, but practicing these easy steps will always ensure you have a healthy score.
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