Bill-paying procrastinators, your credit is less at risk!
Americans’ debt profiles have undergone some changes over the last several weeks, with adjustments that should make it easier for some folks to tap into credit, particularly if their worst habit is making a late payment now and then.
Early this year, the proprietary system that the Fair Isaac Corporation uses to generate its vastly popular credit scores (Stock Quote: FIC) saw some serious tweaking designed to make that system a more accurate predictor of credit risk and consumer payment capability.
Some quick history: Fair Isaac, known as “FICO,” was established in the 1950s by engineer Bill Fair and mathematician Earl Isaac. FICO’s risk score model is the most popular system of its kind worldwide. In the United States, FICO rents the model to credit bureaus Equifax (Stock Quote: EFX), TransUnion and Experian, which in turn sell their own particular ratings calculations to financial institutions offering consumer credit, as well as to consumers themselves.
FICO’s role is to “extrapolate information from your credit file and crunch it into one numeric score,” says George Boelcke, president of Vantage Financial Consultants and author of It's Your Money! Tools, Tips and Tricks to Borrow Smarter and Pay it Off Quicker.
FICO scores range between 300 and 850, with under 620 considered risky. The U.S. average credit score is 723, says Boelcke.
“The actual scoring model is like the secret Cadbury chocolate formula,” says Boelcke. Known credit factors considered include
the total amounts you owe, your payment history, how long you’ve had a credit history and new credit applications.
Given that the score is a predictor of whether or not someone is going to be able to pay their bills, it’s critical that lenders—who have significantly tightened the credit spigot—are dealing with scores they can rely on, Boelcke observes.
New, key changes include the following:
1. Your credit is your credit. You can no longer piggyback on another card user’s debt rating. “If you have a credit card in someone else’s name, making you an authorized user, the credit rating benefit will no longer be part of your file,” says Boelcke. Whereas one consumer's credit history on a card used to be to be “imported” onto the credit report of someone added to a card as a secondary authorized user, the practice artificially inflated some scores by as much as 100 points or more, according to one report.
2. One late payment will no longer kill your credit score. That change makes good sense and will come as welcome news to many people who are responsible payers but miss a pay date once in a while, says Boelcke.
3. Extra late payments will now hurt you extra. If there’s a trend of being in arrears—that is, missing payments for 90 days or more—your score will now be socked harder.
4. Things are now more relative. There are now four new “bad” categories reflecting what is in arrears instead of the previous system, in which there were only two, says Boelcke. He adds that the new system is more specific, and distinguishes between a $100 late payment on a department store bill and an outstanding $10,000 car loan, for example. “That didn’t used to matter.”
In addition to these changes, Boelcke says credit card consumers should also be aware that credit agencies are cutting back on their liabilities and many have started to call back more inactive cards. For this reason it is best to test drive all your cards at least twice a year. Otherwise, you may lose the limits attached to some of your cards, making your ratio of outstanding debt to available credit look much more severe.
Also, all debt is not created equal. Lenders prefer a borrower to have a diversified mix of instruments including secured debt like home equity lines of credit and auto loans, together with unsecured forms of debt like credit cards, where there is nothing to show for the loan in question, and less incentive to pay it off.
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