4 Changes in FICO Credit Score Calculations

by Michelle Vullo Pastor   

FICO 08 changes some rules for credit scores

Do you know your credit score? You may soon see a big difference in your score because FICO is changing the way it's calculated.

Your FICO credit score is used by banks and financial institutions to determine your creditworthiness when you apply for credit or a loan. Your score is calculated using a variety of factors.

FICO's current scoring model will change when "FICO 08" is rolled out sometime during 2009. The release of FICO 08 was delayed for more than a year by lawsuits contesting some of the changes that the new credit scoring model will employ. Backers of FICO 08 say the new credit scoring formula will prove to be a better predictor of defaults.

  1. Greater emphasis on available credit
    One of the principle changes FICO 08 will incorporate is an increased sensitivity to borrowers' available credit. Many credit card companies are slashing credit limits and closing unused accounts, thus decreasing available credit. Whether they carry a monthly balance or not, many borrowers have less credit available to them than in the past; this alone could send credit scores plunging.

    To ensure that the new emphasis on available credit doesn't hurt your score, you'll need to keep a number of credit cards open, charge a small amount on each card to keep the accounts active, and pay the balances off in full each month.

    One way to do this automatically is to sign up for automatic credit card payments for each card with a recurring expense, such as a Netflix subscription, telephone bill or cable bill. It's better to have five different credit cards, each with a $1,000 limit, and only charge $100 per month on each card, leaving you with $4,500 available credit, than to have one card with a $1,000 credit limit and charge $500 per month, leaving you with only $500 of available credit.
  2. Small debts won't affect your credit score
    FICO 08 does have some positive changes for consumers as well. The new formula will ignore small collection accounts where the original debt was $100 or less. These are debts typically created by unpaid library fines, parking tickets or small medical bills, any of which could easily be overlooked by a consumer.
  3. Less emphasis on isolated credit setbacks
    In another victory for consumers, borrowers who experience a single, isolated credit setback, such as a repossession, won't be punished as severely as in the past, as long as all other active accounts are in good standing.
  4. Authorized users can still improve their credit scores
    In 2007, credit repair companies began abusing the "authorized user" feature on credit cards. The authorized user feature was intended to be used mostly by parents or spouses who wanted to help their child or partner improve their credit by temporarily being named an authorized user on the credit card of the adult who had better credit. Some credit repair companies began soliciting borrowers with good credit who were willing to make complete strangers authorized users on their credit accounts, for a fee.

    To put an end to such fraud, FICO initially intended to stop allowing such "piggybacking" to benefit a borrower's score; the company has since backed off from that decision, due to potential credit fairness issues. Some authorized-user information will continue to be factored into credit scores, but the effect of that information on credit scores is still unclear.

Each of the three major credit bureaus — Experian, TransUnion and Equifax — compiles a FICO score based on the information in their databases; they do so using guidelines established by FICO. Mortgage lenders will generally review all three scores and use the middle number to determine how much credit to extend borrowers, and at what interest rate.

One problem with FICO 08 is that only TransUnion will be offering it soon, which means many lenders won't adopt it immediately. Lenders will want to wait until all three credit bureaus are using the new system, which will allow them to assess scores based on the same criteria. Because FICO 08 could raise or lower some scores by up to 20 points, it could be confusing if both the old and new scoring formulas are used together.