What’s your credit score?
FICO changes are coming down the pike. Should you be concerned?
From the pages of In Business magazine.
Later this year, FICO is expected to announce new measurements for credit scores that will impact just about anyone looking to purchase homes, extend credit card terms, or buy insurance. Should you be worried? It depends, say local experts.
Anyone who has ever owned (and used) a credit card has a credit history and a credit score, and good credit is critical when applying for mortgages or credit cards to ensure the best rates.
When implemented, the new FICO 10 will put more emphasis on personal loans, while FICO 10-T will look back 24 months to establish a credit trend, taking credit card payments into account.
That could make bad credit scores worse, and good credit scores even better, but the majority — almost 110 million people who regularly pay their bills on time — may not see much impact.
FICO is not a government program, it is actually an acronym for Fair Isaac Corp., a California-based firm that established the first algorithm assessing credit worthiness using data from all three credit bureaus — Equifax, Experian, and TransUnion.
There are hundreds of such companies and scoring models used for various purposes, but FICO, used by about 90 percent of U.S. lenders (according to its own data) and VantageScore, a separate and competing company launched in 2006 by the credit bureaus themselves, are the dominant two.
FICO and VantageScore use the same scoring range, from 300 to 850, to determine a person’s borrowing power, but each has different metrics to get there.
Credit scores determine creditworthiness based on a variety of factors, and credit bureaus neatly package credit activity with a three-digit score — the higher the score, the better a borrower’s ability to repay a loan. But what goes into a credit score, and what activities can help or harm that number?
We asked local credit experts for their take, including: Mike Long, executive vice president and chief credit officer at UW Credit Union; Jason Stampfli, owner/senior mortgage advisor, Stampfli Mortgage; and Trent Sveom, vice president of mortgage lending at Park Bank.
Weighing the differences
VantageScore measures credit differently than FICO, but if an individual has a good credit score on one, they’ll likely have good credit on the other. Last year, 59 percent of Americans had a FICO score of 700 or greater, the largest percentage ever.
Someone looking for a home mortgage may not know (or care) which scoring system their lender uses. What is important, though, is that their credit score, for the most part, hovers around 700 or above.
Credit Karma, a free online credit scoring service that uses VantageScore, notes some basic differences between the two services:
FICO weighs credit scores using five key categories:
- Payment history, 35 percent;
- Amounts owed, 30 percent;
- Length of credit history, 15 percent;
- New credit, 10 percent;
- Credit mix, 10 percent.
VantageScore looks at six categories, but influence levels vary:
- Payment history, extremely influential;
- Age and type of credit, highly influential;
- Percentage of credit limit used, highly influential;
- Total balances and debt, moderately influential;
- Recent credit behavior and inquiries, less influential;
- Available credit, less influential.
Since 2017, tax liens and judgments haven’t been as heavily weighted as in the past, but they can still impact both FICO and some VantageScore credit models.
Mike Long, at UW Credit Union (UWCU), admits credit scores can be confusing to borrowers because lenders are free to use whichever scoring model and version they want. UWCU, Long notes, relies on VantageScore version 3, for example. “We find it more predictive for our customers.”
An individual can have a 750 FICO score at one bank and a 775 VantageScore at another. Complicating matters, the credit bureaus may not update their information at the same time.
FICO 8 (2009) is the most commonly used version nationwide, even though FICO 9 succeeded it in 2014. FICO 9 attributes less weight to medical debt but may consider rent payments (if available).
“FICO has become as ubiquitous [to credit scores] as Kleenex is to facial tissues,” Long remarks.
Every several years, credit scoring companies change their credit scoring algorithms to better calculate ways to measure risk, he explains, so this really is nothing new. FICO’s updates won’t “change the world,” Long insists, as long as consumers continue to use credit responsibly. “Using a credit card and paying off the balance every month is a responsible way of using credit and shows you can handle your credit loan.”
Jason Stampfli owns Stampfli Mortgage, an independent mortgage company in Verona. He agrees that FICO’s changes to version 10 and 10-T are adjustments needed to adapt to current spending trends. “Back in the day, things were done on a handshake and defaults were rare, but now they’re adapting their models to fit with the trends of the risk.”
For home mortgages, Freddie Mac and Fannie Mae dictate everything, Stampfli says. Each has their underwriting engines, or software — Freddie Mac is LP (Loan Prospector), and Fannie Mae is DU (Desktop Underwriter). Lenders plug credit info into the software which takes into consideration all the guidelines that Freddie and Fannie have, as well as those for government loans known as VA (Veterans Affairs) and FHA (Federal Housing Administration).
But even Freddie and Fannie have been using older FICO models 2 (Experian), 4 (TransUnion), and 5 (Equifax) to determine credit scores.
And FICO’s anticipated changes don’t require Freddie or Fannie to implement them right away. “There’s a timing to this,” says Stampfli. “It’s up to them, but when they do, all the creditors working with mortgages will have to change their models when they re-pull credit reports so it matches the software we’re running. Until then, it’s business as usual.”
Things will change eventually, he says, and when they do, stronger buyers will be stronger, but weaker buyers with lower credit scores could be most impacted and face rising interest rates, for example.
“It could affect affordability in terms of buying a house and pigeonhole those buyers into renting.” Rental rates could rise for them, too, because of the lower scores.
Credit scores for home mortgages are based on data collected from the three credit bureaus, with the qualifying score being the middle of the three.
For example, if a borrower gets a credit score of 680 from Experian, 715 from Equifax, and 703 from TransUnion, Freddie and Fannie will instruct lenders to use the middle score, or 703, for underwriting.
If only two scores are used, the credit score is generally the lowest of the two. Auto loans may require just one.
“When people are getting ready to purchase a house, they may watch their credit score online from free services and think they have a 700 score when they in fact have a 660. That’s significant,” Stampfli says, “so I always ask where they came up with that number. Right now, FICO’s scores are lower than Credit Karma’s.”
Credit scores have been so confusing for some that Stampfli says there have been whispers of lawsuits to sort it all out.
“What I do know is that it costs more to purchase a house when you have a lower credit score. Everything gets more expensive — homeowners insurance, interest rates; you just pay more on the whole because you’re considered high-risk.”
Caution: No secrets allowed
Ever since the housing crisis and Great Recession, borrowers have been put through the ringer because investors want a paper trail and look at all financial records to connect the dots and ensure they’ll be paid back on time.
Underwriting guidelines have tightened significantly, adding layers of complexity. “They look at everything,” Stampfli cautions, from the bank statement to overdrafts to how someone manages their money. There are no secrets anymore.”
Deposits from outside of employment will also be scrutinized.
Stampfli explains: “Most people would think it’s no big deal if someone has $3,000 in a safe that they suddenly decide to put in their savings account. It’s being responsible, right? They want to earn interest on that amount.
“But investors look at things differently. They don’t know the situation. They don’t know the borrower, and they will want to know if that person was trying to do something on the side.”
People who don’t report of all their money also don’t receive the benefits of reporting, he adds. “That’s why self-employed borrowers often have a difficult time qualifying. Smart accountants want to try to make that bottom line [income] as low as possible, but when that person goes to purchase a home, the only thing the government cares about is how much they’re reporting.
“So, if you’re saving money on your taxes by not reporting income or writing everything off, you may not be able to show enough qualifying net income,” Stampfli says. “W-2 employees, on the other hand, qualify based on gross income.”
The new FICO system, he says, will mostly hurt people who take out personal loans to consolidate credit card debt and then begin using credit cards again.
“That’s a bad situation,” Stampfli says. “People have to live and learn, but if they don’t, they’ll be considered high-risk.”
Park Bank’s Trent Sveom says FICO’s new 10-T model will focus in on credit card payments. “How long is someone carrying higher-percentage balances? Is it an ongoing trend or are they using it and paying it down every month? That’s where I think the newness will come into play and how it may affect consumers.”
Lenders have always considered credit history going back several years, Sveom notes, but until FICO 10-T there hasn’t been a trended measurement at the credit trade-line level.
That’s why those who are best utilizing their credit and paying their bills on time will likely see minimal impact.
If significant purchases are planned, it is sage advice to check credit scores.
No matter what the credit score, there’s plenty a person can do to improve it.
Because FICO 10-T will use recent history more effectively, UWCU’s Long says missed credit card payments will weigh heavier on a credit score. He suggests keeping the amount of credit to less than 35 percent of the credit limit. “If you have a $10,000 credit limit on a credit card, keep that balance under $3,500.”
Online credit report tools like Credit Karma or Credit Sesame can be used to monitor credit scores, but the three credit bureaus also can provide a free credit report once a year.
Choose one and stick with it, Long advises, but don’t check it every day unless there’s a solid reason — like identity theft.
That said, credit scores are critical pieces of information that can help people get the best credit terms and pay the least. Knowing where they stand is the sign of a responsible consumer.
“[Lenders] report to the credit bureaus every 30 days. If a credit score dips due to a missed payment, it could take as much as six months of current payment history to work through before you get it back to where it was,” Long cautions.
Stampfli suggests taking the free credit report models at their face value to flag any negative or positive impacts that could cause issues, including outstanding payments. “I’m seeing a significant amount of medical collections right now,” he says. “In most cases, co-pays under $50.”
In Wisconsin, those can be the easiest to remedy, Stampfli notes. “In my opinion, medical collections should always be paid off first because they can instantly wipe years of late payments off someone’s credit report. I’ve seen some scores jump 100 points because of that.”
He also suggests people pay their bills early, if possible. “Ask your local bank or credit union when they report to the credit bureaus each month, then pay the balance down at least five days prior to that day, not the due date.”
Another tip is to pay credit down, but not necessarily off. “Even a small balance requires a borrower to pay something every month, which proves ability to pay, and don’t close credit card accounts,” Stampfli advises, “because it could wipe out all of their credit history.”
Park Bank’s Sveom takes the looming FICO changes in stride. “The impact of this may affect about 10 percent of consumers at both ends either positively or negatively, but the vast majority likely won’t see an impact.
“We’ve been through these revisions before and everyone braces for it, but six months later, nobody talks about it anymore.”
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