New FICO® Score: What You Need to Know About the Credit Scoring System in 2020
Fair Isaac Corp (FICO) recently dropped some big news that it will debut two new versions of its credit scoring system in summer of 2020 — the FICO® Score 10 and the FICO® Score 10T.
With that announcement, there are lots of questions as to how this new credit scoring system will impact consumer credit scores, chances of getting a loan and overall credit health. Whether you have excellent credit or you’re working on rebuilding your credit score, understanding the role FICO 10 will play in your credit score is crucial.
Here’s what you need to know about the new FICO score system and the changes coming this summer.
What Is a FICO Score?
A FICO score is a three-digit number that estimates your credit risk, influencing everything from your ability to get credit to the interest you pay on credit borrowed. Essentially, your FICO score is calculated in the following way:
- Payment history (35% of your score): Your habit of making on-time payments.
- Credit utilization (30%): The ratio of total credit used to what’s available to you.
- Length of credit history (15%): How long your credit accounts have been open.
- Types of credit (10%): The types of credit in your portfolio such as bank credit cards, auto loans, mortgages or student loans.
- Credit inquiries (10%): Requests for credit report information on behalf of a lender or other authorized party.
FICO scoring models update approximately every five years — the last time was in 2014, with the introduction of FICO 9. FICO 8 was released in 2009, which is the most widely used model today. So what’s the purpose of the update? Just like Facebook and Instagram have regular updates that allow the platforms to better understand user behavior, FICO’s updates help lenders better identify how risky you are as a consumer.
In fact, FICO Score 10 isn’t all that different from FICO’s current model, which makes life a whole lot easier for lenders when they convert to the new model. What you really need to know is that the new FICO Score 10T will take into account trended data from the credit bureaus.
How Is the FICO Scoring System Changing?
FICO 10T comes with two major changes: trended data and a heavy weight on personal loans.
In addition to the traditional factors that make up the slices of the credit score pie, FICO 10T will look at trended data — hence the “T” in 10T. This is different from past scoring models in that it will use past credit data to predict consumer behavior, even looking at up to 30 months of historic credit data to draw predictions about future consumer credit behavior.
This means that if you’ve been working hard to pay off your debts, there’s a higher likelihood of reward — that’s good news for you. On the flip side, if you've amassed more debt in that time frame, you’re likely to see a drop in your credit score.
Another change in the new FICO scoring system is how it will weigh personal loans. In a nutshell, this component is designed to discourage borrowers from consolidating existing debt with personal loans, then going out and racking up more debt on their credit cards. This is a prime example of what we mean when we say the new score will take into account user behavior — essentially, it’s looking at the consumer’s behavior when it comes to debt. Are you utilizing a personal loan to pay down your credit cards and streamline payments? Or are you abusing it and creating more debt for yourself?
In addition to being more predictive, FICO 10 and 10T will allow lenders to scrutinize borrowers in more detail. Trending data in 10T is thought to be a response to the last economic crisis. Because derogatory marks fall off credit reports after seven years, lenders no longer have data to help them understand how consumers handled the last economic crisis (from a financial perspective), and trending data is thought to provide predictive insights for the next one.
What Does FICO 10 Mean for My Credit Score?
Of course, what you really want to know is how the update will affect your credit score.
If you have good credit and practice responsible debt management, it’s unlikely that you’ll see much change to your credit score. In fact, you may even see your score rise. If you have high debt-to-credit ratios, frequently take out personal loans and acquire credit card debt, or struggle to pay lenders on time, it’s likely that you’ll see a significant decline in your score — possibly even a drop of 20 points or more.
One of the benefits of FICO 10 using trended data is that your score is most likely to rise if you only have the occasional high balance. For example, if you put vacation expenses on your credit card but then pay off the balance quickly, you won’t be penalized the way you would have been under previous FICO models. This is because the trended data looks at your balances over time and sees you bringing a temporary high balance down.
Who Needs to Worry About FICO 10?
That said, roughly 40 million people are projected to see a drop of 20 points or more. If you’re part of the latter, this could mean that you’re at greater risk for being denied a loan or having to pay a higher interest rate.
Your score is most likely to drop if:
- You’re using credit cards to get by and haven’t chopped down those high balances, or your balances continue to grow.
- You took out a personal loan to consolidate credit card debt, but now your credit card balances are back up or you’ve applied for additional credit.
When Will Lenders Start Using the New Score?
FICO 10 doesn’t officially roll out until summer 2020, giving you some precious time to figure out how you’ll be affected by the new model and what your game plan should be.
Additionally, adoption by lenders could take longer — as long as six months to a year. Significant transitions in scoring models can prove challenging, especially for large lenders.
That said, large institutions have a significant incentive to migrate to the new model as soon as possible. According to Dave Shellenberger, vice president of scores and predictive analytics at FICO, “When we release a stronger more predictive model we see that lenders will migrate to the stronger model because it allows them to make more loans to more consumers without taking more default risk.”
Forbes reported that Equifax will start using FICO 10 as soon as it’s available, but as of now, FICO 8 still remains the model most commonly used by lenders. Other lenders may not even use FICO, instead using alternative scoring systems like VantageScore.
Best Practices With the New Scoring System
Credit scoring methods have always been a way for lenders to minimize the risk of approving a customer who won’t hold up their end of the bargain — i.e., not paying what’s agreed. So, while you might be inclined to panic with all the buzz around the FICO 10 model, best practices for managing credit card debt essentially remain the same.
Here are the best practices you should follow to keep things in check:
- Pay all your bills on time.
- Keep credit card utilization under 30 percent.
- Pay down your credit card balances. This goes without saying, but consistently high statement balances — or rising balances — can suggest financial difficulty.
- Even if you have high statement balances and make on-time payments, it’s always helpful to make additional payments throughout the month.
- Avoid relying on credit cards for emergencies. Instead, have a healthy emergency fund so you can avoid rising balances that hurt your credit scores.
- Be cautious about applying for new credit. An influx of new credit applications or hard inquiries can signal financial distress.
- Keep old credit card accounts open.This is an important factor in credit utilization and debt-to-credit ratio. Keep your accounts open unless you have a compelling reason to close them, such as a high annual credit card fee.
These changes are something to keep in mind as you plan your finances this year and monitor your credit score. If you want to know more about how to improve your credit score, Credit Repair has you covered from education on debt solutions to credit improvement.
from a Credit Expert