After years of increasing credit scores, FICO, the fico credit score used by the majority of lenders, has done an abrupt shift. FICO Score changes in how the most widely used credit score in the U.S. is calculated will make it harder for many Americans to get loans. What is changing in the new scoring? Why were these changes implemented? How will it impact you?
What is Changing in the new credit scoring model?
Over the last 10 years credit scores have been on the rise due to various changes to the model including a settlement with states to not include judgements or tax liens into the credit score. Many lenders have felt these changes have gone to far and do not appropriately highlight the risk of a consumer default. As a result, Fico has made 4 major changes to better assess the riskiness of the borrower:
- Consumers with rising debt levels will see a score reduction
- Recently missed payments will carry more weight in the FICO score
- Consumers who sign up for personal loans or payday loans will be deemed riskier resulting in a score reduction
- More emphasis on utilization, meaning a greater emphasis will be place on the percentage of your available balance you are using. For example if you have a credit card limit of $5,000 and consistently use $4500 of it your score will be lower than someone who utilizes $1000 of their $5000 balance.
Why were these changes being implemented?
The new FICO changes reflect a shift in U.S. lenders’ confidence in the economy, which has been expanding for more than 10 years. Consumer loan losses remain low compared with during the last recession, but consumer debts are at record highs, with many Americans forced to rely on debt to help fund their everyday lives.
Lenders in recent years had asked the credit-reporting and scoring companies to help them find more borrowers. But lenders are also trying to balance the need to expand loan volume with a rising concern about the longevity of the economic recovery and whether credit scores are making some consumers appear more creditworthy than they are.
“There are some lenders that see there are problems on the horizon in terms of consumer performance or uncertainty [about] how long this [recovery] is going to go,” said David Shellenberger, vice president of scores and predictive analytics at FICO. “We definitely are finding pockets of greater risk.”
What is the impact to consumers?
The new scoring model will have some impact scores across the board with the greatest impact to the lower scored borrowers (below 650). The biggest impact to all borrowers will the be the emphasis on credit utilization and increase in credit as many consumers have been on a buying/borrowing binge with rates at historic lows. This change in FICO will highlight borrowers that are using more debt than in the past and also using more debt as a percentage of their available debt. I’ve seen this first hand as my credit score will vary by month based on how much I spend on my credit card. Even though I pay the card in full and don’t carry a balance, if I spend more in a single month (even with my utilization low) the credit score drops 20-30 points.
It is interesting that merely applying for a personal loan will have a detrimental impact on your credit. Personal loans are one of the fastest growing “fintech” products. The Personal loan is a spin on the payday loan with longer maturities and rates ranging from 30-100%. With rates like this FICO is correct to be worried about these products and flag consumers that utilize them. Unfortunately, this will create a self-fulfilling cycle where consumers are never able to get out of these products due to their now lowered credit score.
The new credit scoring models will attempt to reign in the “grade inflation” of credit scores over the last several years with many consumers facing lower scores. If you haven’t done so already, now is the time to review your credit report to try to lower your credit utilization while at the same time avoid personal loans if at all possible.
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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