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Every few years Fair, Isaac and Company, also known as FICO, changes the way FICO credit scores are calculated. It’s important to understand the changes because about 100 million people will see their credit scores change. The 2 new scores offered, FICO 10 and FICO 10 T, were created to allow lenders to better understand the risk of borrowers. These new credit scores will be adopted by lenders in the next 1-2 years. Read on to be prepared for these new changes.
Credit Utilization
The current FICO credit score only looks at your current credit utilization, which is the amount of revolving credit you are using divided by the amount of revolving credit you have available. So it’s a snapshot of your current credit card balance. The FICO T will consider the past 2 years or more to better predict your behavior going forward. This will affect people who plan to get a new line of credit and are used to simply paying off their credit cards right before they apply. Now you will have to be responsible for keeping your balance low 2+ years as people with high balances over this period will see bigger penalties on their credit score. The general rule of thumb is to keep your credit utilization ratio below 30%.
Recent Missed Payments
Credit scores are used by lenders to determine if you are responsible enough to lend to – they just want to get their money back! For this reason, it’s important that lenders see if you are currently struggling financially before they approve you for a new line of credit. So these new credit scores will have greater penalties for recent missed payments in an effort to alert potential lenders that this applicant is in a financial crisis and probably not able to pay off a new credit line.
Personal Loans
As more and more personal loan providers have entered the market, the interest rates have become so competitive that people are abusing the opportunity to take out a personal loan. You should never take out more credit than you need. The new FICO credit scores will penalize consumers who are using personal loans irresponsibly. For example, if you consolidate your credit card debt into a personal loan and then start racking up a big credit card balance again the new credit scores will penalize this behavior more than the current score.
What You Should Do
After these new scores are adopted by lenders, it will be too late to make big improvements to your credit score in a short period of time. Our advice is to make it a priority to make all of your payments on time and use under 30% of your available revolving credit at all times. Although these new credit scores weigh the importance of some factors differently, the main 5 credit factors that determine your credit score will remain unchanged.
You can get your FICO credit score for free from Experian. It offers access to your Experian credit report and includes credit monitoring and alerts. Experian Boost also enables you to improve your credit score by adding payments that are left out of your credit history, like cell phone, utility bills and even Netflix, to your Experian credit report. The best part is that it’s free!
Financial freedom begins with good habits.
Rebecca & Tiago, theloadedpig.com