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The Fair Isaac Corp., the creators of the FICO score, announced big changes this summer to the scoring system. Every 5 years FICO updates their credit scoring systems - this time they are introducing two new scores. Although lenders don’t immediately start using these new scores, they can still have a major impact on you.
The new FICO scores will look more closely at personal loans and credit card debt and will look at your credit history over two years (instead of a point in time).
Personal loans and credit card debt: For the first time, the new scores will closely track personal loans and penalize borrowers if they consolidated their credit card debt but went on to accumulate more debt on their credit cards. Users who use credit cards to get by without ever decreasing their balances will also see their scores drop significantly. Consumers who have a high “utilization” ratio - meaning that the balance on their credit line is nearly equal to the max spending limit - can also be affected.
Credit history over two years: The new scores also show consumer data over 30 months. Lenders can take a look at the borrower’s spending activity and repayment patterns to see borrower’s credit habits. This will be used to see how debt has changed over the past 2 years to predict what consumers will do in the future. The old score only looked at a certain point in time, while the new score will look over two years. This means recently missed payments will be seen more harshly while on-time payments will be more favorable.
FICO announced that millions of consumers could be affected. These changes are expected to create a bigger gap between consumers who have good or bad credit. Consumers with a high FICO score who continue to manage and make their loan payments on time will likely see their score increase. Consumers with a low score who continue to miss payments and accumulate debt will see a bigger decline in their score.
The most important thing to know here is that regardless of which scoring system your lender uses, the fundamentals for having a good credit score remain the same:
We recommend paying down the balances on your credit cards and avoid consistently keeping high balances. If you max out your credit card every month, instead of making one full payment consider paying payments twice per month and aim to keep a credit utilization ratio of less than 30%.
If you don’t already have one, you should start an emergency fund. Having an emergency fund will keep you from turning to credit cards during an emergency - as rising balances could hurt your score.
The new score changes will look at your data for up to 30 months. If you vacation in a specific month and put all the expenses on a credit card and then pay it off, you won’t be penalized. But if you decide to consolidate credit card debt with a personal loan, and continue to rack up debt on your credit card, you will be heavily penalized.
As a last tip, if you are looking for a quick boost to your credit score we recommend signing up for Experian Boost. We tried it here ourselves at Snowball Wealth and saw our credit score go up! The credit bureau offers a service in which by connecting your bank account, it finds qualifying on-time bill payments (such as cell phone, utilities) and adds them to your credit file. You will see the changes to your credit score instantly, and on average users have seen their scores increase by as much as 13 points.
At Snowball Wealth we take a look at your full loan picture to see how much you are paying in interest and provide personalized goals and recommendations on how and when to pay off debt. You can sign up here.