April 28, 2020
Your Credit Score Might Change. Here's Why.
The formula that calculates FICO credit scores will change later this year
In the year so far, the U.S. economy and job market have seen massive shocks due to the impact of COVID-19. Millions of Americans have lost their jobs or have seen their paycheck reduced. Though the federal government has provided some stimulus money to help individuals, many people have had to rely on loans and credit cards to cover their expenses. Unfortunately, this type of financial behavior could soon have a negative impact on those peoples’ credit scores. Americans might see their credit score change sometime this year due to a new formula from The Fair Issac Corporation – the company that issues the widely used three-digit FICO score. The main takeaway is that consumers who use their credit responsibly could see their scores rise, while people who rely heavily on credit and debt for their finances may see their scores fall.
Credit score models are adjusted every few years to account for changing consumer behavior and emerging patterns. Americans as a whole are doing better at making payments on time, which has boosted credit scores across the board. But the average consumer is also taking on more debt, which creates a risk for borrowers and lenders alike.
The new versions of the score – dubbed FICO Score 10 and 10 T – place a heavier weight on personal loans. In particular, those who consolidate debt with personal loans and then borrow more money will take a hard hit to their credit scores.
Additionally, the 10 T formula includes “trended data” for a borrower’s past two years of credit history, intended to reward progress toward paying off debts such as student loans or mortgages. However, the measure can also penalize people who have taken on more debt in their recent history, driving their credit score down.
These changes make paying on time all the more important. Late payments, especially an established history of late payments, will hurt your credit score more under FICO 10 than they do currently. It’s also true that someone who currently has a good credit score will see a larger drop after a single late payment than someone with a lower credit score. Bottom line: do everything you can to make loan and credit card payments on time!
When will these changes take place?
The Fair Issac Corporation will release the new formulas this summer. But it’s hard to say for sure when Americans will see changes, as lenders might not switch to using the new score right away.
Trying to understand how your credit score is calculated can feel like gazing into a cloudy crystal ball. You might be able to see the outcome, but you’re not sure how it got there! Add to that confusion with the fact that lenders might not tell you which FICO version they’re using to get your score, and it can be hard to say how exactly this change will affect you in the short term.
Your credit score could vary significantly between the new and older FICO scoring models, but most U.S. consumers will only see modest swings. If your credit score rises, you could be eligible for a wider variety of credit cards and see better terms on loans and mortgages. However, if your score falls, you may find it harder to get approved for a loan and face fees or higher rates on things like cell phone bills and insurance.
If you are applying for a new mortgage, you might not see a change for some time. That’s because most mortgages are backed by government-sponsored entities like Fannie Mae and Freddie Mac, which are required to use older versions of the FICO formula.
You are entitled to one free credit report per year from each of the major credit reporting agencies (Equifax, Experian, and TransUnion). If you haven’t requested your credit report before, it’s a good idea to do so now so you can correct any possible errors before the new score is released. Equifax will be the first reporting agency to offer the updated scores sometime this summer.
What should I do if I need money?
While taking out loans will always have an impact on your credit score, there are ways you can mitigate the negative effects while ensuring you still have access to the money you need. One way is to take advantage of the equity in your home to secure a loan. Often referred to as a “second mortgage,” these home equity loans can be a great way to borrow without taking a heavy hit to your credit score – especially if you’re already in debt.
No one likes having a low credit score. But it’s important to remember that it takes much longer to recover from bankruptcy than from the credit score hit that comes with taking out a loan. Your score will improve over time with consistent, on-time payments. A bankruptcy declaration is a public record that will stay on your credit report for seven (or even ten) years.
If you need a loan, you can apply online or get in touch with one of our bankers to learn more. We’ll be happy to assist you.