FICO Update: Changes to the Way Your Credit Score is Calculated
FICO (the Fair Isaac Corporation) is one of the three companies behind the way your credit score is calculated and has recently announced the newest update to its software and algorithm. Released in January 2020, FICO’s newest update is called “10T.” The announcement has caused slight hysteria online and rumors of a big drop in credit score for much of the population, which would lead to a decrease in the credit options and interest rates available. However, FICO predicts that this update might impact the credit scores of up to 40 million individuals of the population, but most will move by just 20 points in a positive or negative direction.
In this article, we’ll be going through the actual changes and exploring what this might mean for your credit score. In saying that, a large number of lending firms still haven’t updated their software since 2009, citing that it was too expensive to upgrade in 2014 when FICO 9 was released. This means that while some lending firms have adopted the update, the majority of them are unlikely to change the way they calculate your credit score until at least 2021.
What is the Update?
The 10T (with “T” standing for “Trended”) credit scoring update gives greater weight to historical data which has trended over the previous two years, such as how often debt repayments are made, or how often new lines of credit are opened. This means that if your behavior with money is consistent over time (in either a positive or negative way), you are more likely to see a change in your credit score once lenders adopt the update. According to FICO, this might include consistency in reducing amounts owed or consistency of on-time payments, for example. Trended data has more of an influence in this update, potentially since we are ending the recovery period from the unstable global recession of 2008 and economic behavior could be more predictable nowadays. Its influence on your overall credit score calculations could also be due to the power of habits: future behavior is much more easy to predict after observing past behavior. In fact, the nation’s debt levels rose to unprecedented levels in October 2019, so this update is likely to give lenders a better understanding of who is at risk of default (aka the chance that borrowed money will not be paid back, either on time or at all). The “‘perfect” credit score remains at 800 and will still open up the best interest rates, and the lower the score, the fewer opportunities you may have available.
What Does This Mean For Your Credit Score?
There are two types of people that this update could affect the most. If you were already displaying “positive credit behaviors,” in the sense that you pay bills on time and consistently make the effort to reduce your debts, then you may see an increase in your credit score by around 20 points. Alternatively, if you have consistently missed payments or opened up new lines of credit, your credit score may decrease by around 20 points.
The FICO update may also have a positive effect on those of us who engage in “temporary debt spikes.” For example, you utilize credit for vacations in just one or two months of the year and then are able to pay this off immediately. This is likely to have less of an effect on your credit score when compared to previous versions of the algorithm.
Your Future Economic Behavior
Advice from credit lenders remains consistent:
Pay your bills on time
Work on resolving or at least reducing your debt
Try to clean up lines of credit before utilizing more (i.e. pay off one credit card before applying for another)
The boundaries of fair, good, and excellent credit remain the same and are not likely to change the opportunities available to each who hold these credit scores, such as lower interest rates. This means that working towards improving your credit score is still as important as ever.
If you’d like to sit down to discuss your credit score or other areas of your finances, schedule a chat with me today!