The company that developed the FICO credit score used to determine individual loan qualification and interest rates is making changes to how the score is calculated — and it could mean big changes to your credit score.
Fair Isaac Corp. (NYSE: FICO) plans to add weight to rising individual debt levels and to those missing loan payments, according to The Wall Street Journal.
Customers who apply for unsecured personal loans will also be scored more harshly.
The end result would be that consumers with high FICO scores (around 680 or higher) who continue to manage their loans, will see a boost in their score. Conversely, those with lower scores who miss loan payments will see bigger declines in their scores.
“This is another example of how big data is used in the real world,” Banyan Hill Publishing analyst Mike Carr said. “With the ability to store and process more data, Fair Isaac can show that rapid increases in credit card use that aren’t due to seasonal factors or paying less on credit cards each month are signs of consumer stress.”
FICO Change Reflects View of Economy
Because lending is based primarily on an individual’s FICO score, the change in scoring shows a change in how U.S. lenders view the economy.
In the past, changes to credit reporting, such as removing civil judgments and factoring in utility payments and bank balances, helped boost consumer credit scores and made it easier for lenders to extend credit.
The last change to FICO calculations was in 2014.
However, consumer debt remains high and lenders are starting to weigh the possibility the economic recovery may not last as long as projected.
“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,” David Shellenberger, vice president of scores and predictive analytics at FICO, told The Journal. “We definitely are finding pockets of greater risk.”
The FICO Gap
The changes will likely expand the gap between those who are creditworthy and those who are not.
One new model, the FICO 10T, will penalize those with recently missed loan or credit payments. Those who haven’t been delinquent with a loan payment for more than a year will see their score increase, according to The Journal.
Scores will be lower for consumers who carry credit card balances over periods of time. Paying off credit card debt quicker would see only a slight drop in a FICO score, under the 10 T model.
Those who transfer credit card debt to personal loans will also see a larger drop in their overall score under the changes.
“Updating the scoring algorithm to match reality makes sense. Consumers won’t be hurt but may resort to bankruptcy sooner since they’ll lose the ability to extend payments and pretend they can recover,” Carr said.
The decision to use the new versions of FICO will be up to individual lenders. They can continue to use the previous models or even a competitor like VantageScore.
Carr added the change benefits financial services companies like Capital One Corp. (NYSE: COF) and Discover Financial Services (NYSE: DFC). Those companies may reduce losses due to more strict lending practices.