What Do Recent Changes to FICO Scores Mean for Me?

Dear Carrie,

I heard that there are some recent changes to FICO scores. What’s different, and how will it affect me?

—A Reader

Dear Reader,

FICO scores are odd creatures. We’ve all heard of them, we may even worry about them, but few of us actually understand what they mean in practice or how they are calculated. And sometimes, as you point out, they can change—just adding to the confusion.

Some good news, though, is that even though a few of the details have shifted, the foundational principles of credit scores remain the same. Let’s start with a few basics, discuss what’s changed, and then review the steps you can take to build and maintain your score.

What is FICO?

FICO stands for the Fair Isaac Corporation, the oldest and best known of the credit reporting agencies. Your FICO score, which can range from 300 to 850, is based on your history of using credit, and is intended to help lenders estimate how likely you are to pay back the money you borrow. The higher your number, the better.

It’s important to point out that there are several other versions of credit scores; for example, VantageScore® by Experian. The scoring ranges and algorithms vary by company so you may well see different numbers based on the data that's used, when scores are calculated, and how the scoring models work. Lenders can decide to use a particular company and score for different purposes.

As a reminder, while you can get your credit report for free from each of the big three credit-reporting companies—Equifax, Experian, and TransUnion—every 12 months, you generally have to pay to get your numerical score. Free scores, however, are often available through financial institutions or nonprofit credit counseling services.                                                                                                        

Why is FICO changing?

Credit rating agencies periodically update their scoring methodologies to reflect improved analytics and new data. Lenders are now reassessing borrower risks.

As a result, some banks and credit card companies are already pulling back in certain areas, lowering credit limits for consumers who have poor or shaky credit histories and tightening auto-loan underwriting by increasing borrowing rates.

How is FICO changing?

While the exact formulas used to calculate credit scores are proprietary, the new FICO score is reported to give more weight to rising levels of debt, higher debt utilization (the ratio of the amount you borrow relative to the amount of credit available to you), and late payments. Unsecured personal loans (those that don’t require collateral like a home or car) are also being reconsidered.

On the positive side, individuals who have been making timely payments, paying off debt, and using less of their credit line may see their scores improve. Other recent changes to credit scoring models over the past few years have helped new borrowers with limited credit histories and individuals with tarnished credit histories by considering things like timely rent, utility, cell phone, and cable payments as well as bank account balances.

Why your credit history is so important

Your credit history and resulting credit score can affect more than your ability to borrow money. Banks, stores, employers, landlords, and insurance companies may all have an interest in your credit history. For example, a poor credit score can increase your costs for home and auto insurance. Late payments and collections can lower your credit score and therefore affect a landlord’s willingness to rent you a new home.

Current and prospective employers may be able to use your credit history when doing a background check. This can impact your ability to get a job, your eligibility for a promotion, or your ability to keep a job.

Ways to build and improve your credit score

While it’s true that FICO scoring models have changed, the fundamentals of building and maintaining a good credit score remain basically the same.

• Don’t be late. Paying your bills on time has the biggest effect on your score.
• Be careful about how much you owe. Less is better. Increasing loan or credit card balances not only has a negative effect on your credit score, but increases the cost of carrying debt.
• Avoid maxing out lines of credit. Try and keep your debt to less than 30 percent of the amount you are able to borrow.
• Only apply for credit that you need. While it’s important to shop around, if you apply for a lot of credit over a short period of time, it may appear to lenders that your economic circumstances have changed negatively. 
• Check your credit report at annualcreditreport.com at least once a year for errors. Your report won’t include your score, but it will show you your history and what creditors and other parties are seeing.
• Contact your creditors if you are facing difficulties due to COVID-19. This includes your landlord, mortgage, credit card, auto loan and insurance, student loan, utility companies, and other service providers.  Alternative payment options including postponing payment, partial payments, or grace periods may be available to you under the new Coronavirus Aid, Relief, and Economic Security (CARES) Act without harming your credit. These options may not be automatic. Do not assume you are eligible for any relief options.

Continue to monitor and protect your score

It's essential to understand that your credit score acts as your proxy in the financial world. Your score is used to judge your financial stability and reliability. Therefore, regardless of how opaque the system may seem, or how the models may change, it’s important for you to do everything in your power to protect and enhance your score.

If you currently have a good score, congratulations—and keep up the good work. If you have some dings in your credit history, take action, but be patient as it can take time for your score to improve. Be proactive. The time to act is now.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.