The big picture
FICO scoring is changing this summer; the new scores will be called FICO Score 10 and FICO Score 10T. Basically, the idea is that consumers with rising debt levels -- and those who fall behind on core loan payments more -- will be judged more harshly than in previous FICO iterations. The new scores will also flag those signing up for personal loans, which is a category that’s surged in the last half-decade.
In the past, FICO scores had operated almost the opposite way -- it was easier for consumers to increase their scores, such as when FICO dropped civil judgements from credit reports.
These changes are expected to impact millions of consumers. The “most dire” situation is that 40M consumers could see their scores drop 20+ points. Ruh Roh!
Here’s the central takeaway, per Wall Street Journal:
The changes will create a bigger gap between consumers deemed to be good and bad credit risks, the company says. Consumers with already-high FICO scores of about 680 or higher who continue to manage loans well will likely get a higher score than under previous FICO versions. Those with already-low scores below 600 who continue to miss payments or accumulate other black marks will experience bigger score declines than under previous models.
OK. What does this all mean for you?
Yes, what does it mean for you?
First thing to realize: this is not going to impact you anytime in the immediate future. Most lenders are still using FICO 8 for major loans, and FICO 2, 4, and 5 scores for mortgage decisions. These new scores hit this summer, and it will probably take big lenders another year to use them for major decisions -- so in reality, probably fall 2021 is when this impact will start to be felt. You have time!
The number one thing to focus on between now and then is paying down as much credit card debt as possible, even if that means making frequent payments throughout a given month. Consistently high statement balances, or consistently-rising statement balances, are the biggest FICO red flag of financial difficulty, and that’s only going to be more harsh for people under the 10-level scores.
Do not necessarily get new credit, but if you have old credit accounts that you’re paying down, you can keep those open. Why? They contribute to a factor of FICO called “credit utilization,” which is a relatively large scoring factor; they also contribute to “credit age,” which is a smaller scoring factor but something important nonetheless.
The gold standard still applies: key credit balances low and pay your bills on time. That will always help your FICO.
“Installment credit” is still mostly OK
That refers to debts like mortgages and student loans. The student loan situation is a much bigger topic in terms of how it impacts housing -- we covered it here -- but you can have $100,000s of installment credit debt and still have a good FICO score.
Here’s a visual representation of what goes into a FICO score --- >
The 30% tied to what you currently owe is not changing under FICO 10-scores, so keep that in mind.
The whole reason for FICO’s shift seems to be that more and more Americans are utilizing credit debt to essentially just get by, and that’s going to be punished more harshly in an effort -- misguided or not? -- to make us all more fiscally literate.
Again, we are apartment locators and cannot solve macro-level economic problems, because that’s not what we do. (Simpsons joke: “You don’t control the weather, Lisa. Maybe someday. But not now.”) But we know it’s tough out there -- jobs that pay really well are fleeting, and right now the U.S. is actually creating 2x more “bad jobs” than “good jobs” relative to cost of living, and unfortunately that trend has been in place since about 1990.
So, we understand the need to put stuff on credit. We do. We’ve been there. But try your best not to put as much stuff on credit, and/or pay down the balances you have, because come 2021, that’s going to be important. If you’re looking to potentially buy post-2021 -- and remember, owning a home is not for everyone but is an appreciable asset to almost everyone that does it -- then you need a good FICO, and low credit debts/balances will help. So focus your fiscal literacy and monthly budgeting efforts there.
It will impact your ability to rent as well, although the scrutiny of credit scores on rental applications is admittedly a little bit less than on home purchases.
If you have any questions, don’t hesitate to holler at us.