Significant change is coming to how your credit score is calculated.
Fair Isaac Corp., the creator of the FICO credit score system, has announced plans to implement a new scoring system in early 2019. Under this revised scheme, how we as consumers manage the money in our checking, savings and money-market accounts will be counted in our scores. This shift marks one of the largest changes in credit reporting and the FICO scoring system since the 1990s.
This new scoring system has actually been in the works for years. It represents FICO’s latest attempt to boost loan approvals and to ease leery lenders’ fears.
The change comes at a time when the consumer-credit market seems healthy – unemployment is at all-time lows, and consumer loan balances (for things like credit cards, auto loans, and personal loans) are at a high. So, naturally, lenders want to keep a good thing going and keep expanding consumer loan volume.
FICO insists that the new scheme, called the UltraFICO Score, isn’t meant to create a barrier for applicants. Instead, it’s aim is to increase the number of approved applications for credit cards, personal loans, and other debt, by considering the would-be borrower’s history of cash transactions.
According to FICO, this record could indicate the likelihood that the applicant will repay the obligation. Theoretically, consumers with low FICO scores will garner a higher UltraFICO score, thus increasing the odds that they’ll be approved for credit.
Consumers with an average balance of at least $400 who haven’t overdrawn in the prior three months would likely see a boost, FICO said.
Most consumers have little control over what their credit reports contain under the current model (save for the option of contesting inaccurate information). Businesses who extend credit or collect on debts, in essence, provide our payment-history data to the Big Three of credit-reporting firms: Experian PLC, Equifax Inc., and TransUnion. This information then determines consumers’ FICO scores. And then new lenders use this third-party information to make their own lending decisions.
But with the UltraFICO system, consumers will arguably have more control. Proponents of this new way of ranking creditworthiness believe that this score will serve as an appeal of sorts, most likely boosting many less-than-ideal consumer credit reports.
Here’s how it will work: if an applicant’s FICO score doesn’t pass muster, then a lender can offer to have the score recalculated to reflect banking activity. And, an applicant gets to choose which bank accounts they want to have considered before recalculation.
This move is attractive for both lenders and consumers. As it stands, even though a decade has passed since the subprime-mortgage binge almost ruined the US financial system, lenders are still shell-shocked and skeptical of borrowers with low credit scores. Instead of making a business of widespread lending, banks have instead focused only on ultra-creditworthy borrowers for the past 10 years. But this piece of the market pie is largely tapped.
With this reality in mind, lenders have gone to the credit-reporting firms and FICO to ask for help boosting lending without taking on significantly more risk. Similarly, regulators are interested in exploring ways to extend affordable lending to consumers who may have no or low credit scores.
According to FICO, around 7 million applicants with low credit scores as a result of slim borrowing histories will probably see their scores improve under the new system. Additionally, nearly 26 million subprime borrowers will also see higher credit scores, with nearly 4 million seeing an increase of at least 20 points.
FICO’s Senior Director of Scoring and Predictive Analytics David Shellenberger says the new score’s aim is to prevent risky borrowers from appearing less creditworthy than they are, by reflecting positive financial behavior that was previously invisible. FICO is “very focused” on its “ability to separate future good borrowers from bad borrowers,” Mr. Shellenberger said.
I personally think the UltraFICO system could be a boon for borrower’s who are on the credit-worthiness fence. My advice is to be careful with your cash and avoid overdrafts at all costs. It could soon mean the difference between a good loan and a great loan.