FICO, the nation's leading provider of those all-important credit scores that so many Americans can feel they have tattooed to their backs, has announced it is changing the formula it uses to score credit. The changes could boost the scores of tens of millions of Americans.
Here are a few things to know about the changes:
Exactly what is FICO changing?
There are two main changes. One is that FICO will stop docking people for being overdue on a payment, as long as they have ultimately paid the bill or settled with a collection agency. Until now, having a collection on your record — even if your balance was at zero — could impact your credit score as much as a foreclosure or a bankruptcy.
The second change will be good news to people with medical debt, which is about 40 percent of Americans. FICO says it will start giving less weight in its credit scoring formula to unpaid medical bills that are with a collection agency.
So how could these changes affect my ability to borrow?
FICO’s goal is to boost lending without creating more risk. Since the recession, it has been hard to get a loan without fairly spotless credit. These new changes could boost certain scores by as much as 100 points, meaning if you have an otherwise good credit record aside from the above issues, you might qualify for a loan you wouldn't have before, or at least for a lower interest rate.
When do the changes go in to effect?
FICO says they will offer the new credit score formulas to credit bureaus in the fall and to lenders by the end of the year. But just because the new formulas are available doesn’t mean they will be used. FICO rolls out new scoring formulas every few years, and it takes a while for many lenders to adopt the newest versions.
Beyond that, even though FICO has changed its approach to unpaid medical bills and debts that have been resolved with collections agencies, those events won’t disappear from your record altogether. Lenders will still be able to see them on your credit report for up to seven years, and can still decide they are a sign of risk.
What are the pros and cons of FICO’s new approach?
Any loosening of credit standards raises worries in some corners, that it could leave lenders open to more risk or entice borrowers deeper in to debt. FICO doesn't think so. But we'll have to see.
If the company is wrong, it could undermine the credibility of their credit scores.
John Ulzheimer, a credit expert at credit education website Credit Sesame and a former manager at FICO, says what is certain is that FICO carefully considered the changes. “The only reason someone like FICO is going to make this type of drastic change to their scoring system is because the science behind it supports the change,” he says. “As time changes, different data elements on a credit report are tested to make sure they're still predictive of elevated risk.”
For example, as medical expenses have risen sharply in the last few decades, FICO may have found that medical debt is no longer a good predictor of elevated risk.
If FICO is right, and the new scoring system raises credit scores for tens of millions of Americans without opening lenders up to more risk, it could have positive ripple effects on the economy. Part of the slow recovery has been due to tight credit. More people qualifying for loans could create useful momentum.
And don't forget how powerful credit scores have become in our lives. Credit card companies and banks look at them, but so do potential landlords and even potential employers.