How The New Credit Score Will Affect You

Lenders now have a second formula for judging your past, backed by the three giant credit bureaus.

Your VantageScore could look very different from your FICO score.

By Liz Pulliam Weston


The three credit bureaus are touting their new credit-scoring system as a boon for borrowers, easier to understand and more "consistent" than other scoring methods.

Maybe. But VantageScore, which uses the same underlying data about your debts as the FICO score you already know, also poses some serious risks.

Let's be clear: This isn't about making credit easier for the little guy. This is business.

Big business.


Equifax, Experian and TransUnion are private companies that each track your accounts, balances and payment habits.

A credit "score" simply assigns a weight to those factors to produce an indicator of how much risk you show as a borrower.

Fair Isaac's formula (FICO) for scoring is the one lenders like best.

Fico Scores/Reports

Every time an appliance store or car dealership asks one of the credit bureaus for your credit score, the data the bureau has collected about you is sent through the proprietary FICO model.

The lender pays the credit bureau for the score, and the bureau pays FICO for using its formula.

This is quite a lucrative business for Fair Isaac. Credit scoring accounts for 20% of the company's revenues, according to Merrill Lynch analyst Edward Maguire, but 65% of its operating profits.

The bureaus, naturally, want to cut out the middleman.

"They don't like having to pay Fair Isaac for anything,"

said mortgage broker Ginny Ferguson, who teaches credit scoring to her colleagues in the National Association of Mortgage Brokers. "The (credit bureaus) are intent on finding the next area of revenue generation."

The bureaus have tried to break Fair Isaac's stranglehold before, with no success. The VantageScore may be a different story.

Investors certainly think so; they drove Fair Isaac's stock down 6.6% on the day the new scoring system was announced, even though the bureaus hadn't signed up a single lender.

Analyst Maguire rightly called VantageScore "a shot across the bow" of the bureaus and opined that even if the new system didn't replace FICOs, the bureaus could use it as leverage to get Fair Isaac to lower its prices.

We wouldn't have to care about these elephants' battles, except that consumers may be the grass trampled under their feet.


Here are just some of the concerns:


1. Credit score confusion

FICO and VantageScore use two different ranges. The classic FICO scale runs from 300 to 850, while the VantageScore starts at 501 and runs to 990.

The bureaus say the VantageScore range is more "intuitive," because it breaks down like an elementary-school report card:

901-990 equals "A" credit

801-900 equals "B" credit

701-800 equals "C" credit

601-700 equals "D" credit

501-600 equals "F" credit


There will probably be a lot of puzzled borrowers trying to figure out why a number that would qualify them for the best rates and terms under one system - say, a 780 credit score - makes them credit mediocrities under the other system.


2. Consistency

The information in the credit-bureau databases can be wildly different.

You may have accounts reported at one bureau that don't show up at the other two, or you may have successfully disputed an error at two of the bureaus only to have the third refuse to erase the bogus entry.

One of FICO's big selling points for lenders has been the model's consistency.

Even though the bureaus collect and report credit information differently, the same basic FICO model is used at all three to generate comparable scores.


We shouldn't fall for the idea that the new system is superior without more evidence -- so far, VantageScore hasn't been tested head-to-head with FICO.


3. The good, the bad and the ugly -- but mostly the bad

VantageScore is being marketed to lenders as being a better way to separate "good" from "bad" risks including, to quote its Web site, "the ability to classify more bad accounts into the worst-scoring ranges."

Lenders, you see, are often less worried about losing out on good customers than they are about getting stuck with bad ones.

So if a few potentially good risks get wrongly qualified as bad, lenders aren't that worried as long as they avoid the deadbeats.


*** If you happen to be one of those good eggs who's paying higher interest rates or having trouble getting loans, though, you should worry.


Again, the bureaus are quick to say that they haven't tested VantageScore against FICO, so it's unclear whether the upstart actually does sweep more folks into the worst-scoring range.


But the fact that it's one of the bureaus' goals should help you understand the point: this is not about making consumers happier.


4. "Thin" and "Young" credit profiles

One of lenders' beefs about the classic FICO model is that people whose credit histories are "thin" (they have few accounts) or "young" (their oldest account has been established for only a few months or years) can still get pretty high scores.

The lenders grump that these borrowers may pose a greater risk than the scores predict, and that people should have more robust credit files before they reach the top of the FICO pyramid.

Once again, without comparing VantageScore directly to FICO, the bureaus are touting it as a better way to grade people with limited credit histories.

If that means the young or others without "robust" histories get better access to credit to buy homes and build businesses, this could be a good thing. If it means making credit harder to get for those folks, not so much.


5. High switching costs

To say that FICO scores are entrenched in the financial world would be understating the case.

"FICO scores are used by 80% of the 50 largest banks. They're used in 75% of the mortgage loan origination decisions," said Ron Totaro, Fair Isaac's general manager for global scoring solutions. "We're a force because we've been at this for 50 years."

It's not just the lenders that rely on FICO. Most loans today are bundled up and sold to investors, who use the scores to gauge how much risk they're taking with these investments.

Wall Street is comfortable that FICO-scored loans will behave as forecast, Ferguson said, but could be more nervous about the "predictiveness" of a new scoring system.

If lenders begin adopting VantageScores, they might tighten up their underwriting guidelines -- in other words, make credit harder for consumers to get -- while they see how well the loans actually perform.


*** Consumers can stand to reap some benefits from the new score.


For one thing, competition has a way of bringing prices down and forcing companies to improve their products.

But more importantly, the bureaus promise to provide clear guidance about what goes into the scores and how consumers can better their numbers.

How specific that guidance will be remains to be seen, but Kerry Williams, group president of Experian's Credit Services, said that he wants consumers to know exactly how certain actions can affect their scores.

Currently, Fair Isaac offers a FICO "simulator" through the my FICO.com website that can show you how a handful of actions might affect your score.


At the moment we can't buy our own VantageScores, but Experian promises to make them available to consumers in the next few weeks, and the other bureaus say they'll follow suit by the end of the year.

Then we'll have some more information to gauge whether VantageScores really are a better mousetrap -- or just more of the same.



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Collapse In Consumer Credit May Slow Recovery

Millions seek to repair damaged scores — here’s how to get started:

By: John W. Schoen

Among the many legacies of the housing bust is a widespread collapse of consumer credit. In the space of a few years, bankers have gone from lending to anyone with a pulse to demanding a pristine payment history.

The result is a collapse in consumer credit that shows no signs of easing. In September, the latest figures available, revolving consumer credit fell at an annualized rate of 13.3 percent.

The situation is worsening. In the first half of the year consumer credit was dropping at a rate of just under 10 percent.

No one is suggesting we go back to the reckless days of setting up tables at college orientations to hand out credit lines to freshmen. The credit card industry learned the hard way that when their models break, the results can be painful for all concerned.

But the lending spree has destroyed the credit histories of millions of Americans.

The rules of the consumer credit game suggest it will be years before those failed borrowers are able to dig themselves out of the hole. Until those households get access to credit again, our consumer-driven economy will continue to slog along in low gear.

In the meantime, there are steps consumers can take to get back in the good graces of the financial services industry that helped put them in a hole they find themselves in.

"I am trying to build credit for myself and husband. I have a low credit score, and he has none. We bought a truck and it's under both names, so we are hoping after we pay it off it will help with our credit. He has a repo under his belt and I have a couple of phone bills that I let get too high and couldn't pay them off. So my question is, what can we both do to build and increase our credit scores? We want to buy a house in the future and would like to build our credit so it won't be so hard on us. Any information or ideas that could help?
— Crystal, Amarillo, Texas

There are lots of reasons for financial setbacks, some of which you can’t control. With the “real” unemployment rate pushing 20 percent, job loss is a big one. Health setbacks are another; nearly two out of three personal bankruptcies were the result of out-of-control medical bills.

Letting the phone bill “get too high,” on the other hand, isn’t on the list of uncontrollable setbacks. You can fix that right away.

But it will take more than a few months of prompt payments to get back on track. The formula created for scoring credit doesn’t care why your payment history faltered. Maybe you're one of those people who just can't stick to a budget. Or maybe you happened to have hit a period of bad luck.

The credit algorithm can’t handle that distinction. That’s a pretty big flaw in the “science” of calculating credit ratings.


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5 Ways To Kill Your Credit Scores

By Liz Pulliam Weston

One of the questions I'm asked most often about credit scores is exactly how much certain actions affect people's scores.


What good is a good credit score?

Until now, the best I could do was say, "It depends." That's because the company that created the leading credit score, the FICO, has been wary about releasing specifics.

Fortunately, that just changed. At my request and for the first time, the company (also known as FICO) has released details about how specific actions, from maxing out a credit card to filing for bankruptcy, can affect people with different credit scores.

I asked the company to compute the results of those actions for two examples: a person with a 780 score, which is an excellent score on the 300-to-850 FICO scale, and someone with a 680 score. The results:


Effect on a 680 score Effect on a 780 score

Maxed-out card
-10 to -30
-25 to -45

30-day late payment
-60 to -80
-90 to -110

Debt settlement
-45 to -65
-105 to -125

Foreclosure
-85 to -105
-140 to -160

Bankruptcy
-130 to -150
-220 to -240


Source: FICO

The results are given in a range because FICO is still a little nervous about revealing too much about its proprietary scoring. But the range is fairly tight, and we can clearly see the disparate impacts of the different actions.


A Guide, Not a Guarantee.

Before we go further, I have to make this clear: Your mileage may vary.

People with the same credit score can have very different credit profiles: more or fewer accounts, a different mix of accounts, a longer or shorter credit history, use of more or less of their available credit, etc.

Because of those differences, the same action -- maxing out a card, say -- can have different effects on people with the same score, depending on the details of their individual credit profiles.

For the sake of this exercise, FICO assumed both people had several active major credit cards as well as a mortgage, a car loan and student loans.


The person with the 780 score:

Has at least 10 credit accounts in total and a 15-year credit history.
Uses 15% to 25% of her credit card limits.
Has no late payments on her credit reports.
Has no collection accounts or other major negatives.
The person with the 680 score:

Has six credit accounts and an eight-year credit history.
Uses 40% to 50% of her credit card limits.
Was 90 days late on an account two years ago.
Was 30 days late on another account one year ago.


Here's what you need to know about each action and the effect it had:


1. Maxing out a credit card

Using 100% of your limit on any credit card puts you at risk of over-limit fees. It also takes a bite out of your credit score.

Our person with the 680 score might lose 10 to 30 points from this one action, while the 780 scorer could shed 25 to 45 points.

The difference points up an important fact: The higher your score, the more points you tend to lose from "bad" actions. That's because the scoring formula is sensitive to any sign you're getting in over your head. Maxing out a credit card is considered one of those signs.

You also should know that it typically doesn't matter to the formula if you carry a balance or pay off that maxed-out card as soon as you get your statement. What's usually reported to the credit bureaus is the balance on your last statement. Even if you pay the debt in full before the due date, the maxed-out card will hurt your score.


2. Skipping a payment

Mailing a payment a few days late normally won't hurt your score, although you may incur late fees and trigger higher interest rates. The big hurt comes when you miss a payment cycle entirely.

A 30-day-late report would shave 60 to 80 points from our lower-scoring person and 90 to 110 points from our higher scorer. In other words, one lapse of attention could plunge the 680-scorer into subprime credit territory, and our 780-scorer could find credit much harder to get and more expensive.

This is why it's so important to set up automatic payments to ensure your bills get paid on time, all the time. With credit cards, you can set up automatic payments that take the minimum payment out of your checking account to ward against a late payment. You can always make a second payment that reduces your debt or pays it off entirely. You can sign up for automatic payments on the Web site of your card issuer.


3. Settling a credit card debt

All the advertisements about "settling your debt for pennies on the dollar" make debt settlement sound like a great solution. But failing to pay what you owe a creditor will take a serious toll on your score.

The 680 scorer would lose 45 to 65 points with this maneuver, while the 780 scorer would shed 105 to 125 points.

Our scenario assumed that our borrowers would miss one payment before settling the debt with their credit card companies. In reality, debt settlement negotiations can drag on much longer, with each missed payment taking another chunk out of your score.

Settling a debt with a collection agency would hurt less, probably much less, because the FICO formula is set up to weigh more heavily what the original creditor says about you than what a collection agency reports. But if our borrowers were settling with a collection agency instead, their scores would be lower to begin with, because they would have collection accounts on their records.

Also, you should know that the amount of debt your creditor "forgives" in a debt settlement solution is typically added to your taxable income. So you may save some money by settling a debt, but you'll give some of it back to Uncle Sam in higher taxes.


4. Losing a property to foreclosure

Foreclosure deals a severe blow to your credit score: 85 to 105 points for our person with the 680 score and 140 to 160 points for the one with the 780 score.

Foreclosures have implications for your future ability to get a mortgage as well. Although your score may start to improve as soon as the house is gone, mortgage lenders may not be willing to extend you another home loan until two to four years have elapsed.

In an attempt to protect their credit, many people attempt short sales, selling their houses for less than what's owed, with the lenders' permission. Unfortunately, these transactions, even if successful, are often reported as settlements. And a settlement, as you've seen, is pretty bad for credit scores.

To lenders, a short sale isn’t quite as bad as a foreclosure, though, and it may be easier to get another mortgage once you’ve rebuilt your credit.


5. Filing for bankruptcy

FICO spokesman Craig Watts once called bankruptcy the nuclear bomb of credit actions. Filing for bankruptcy would shave 130 to 150 points from the 680 score and 220 to 240 points from the 780 score.

This is different from the other black marks, where the higher scorer was still left with better numbers than the lower scorer. In this case, both would wind up near the bottom of the credit barrel. Getting new credit, particularly in the current credit-crunch environment, would be extremely tough.

Sometimes, of course, bankruptcy is the best of bad options. (See "Quiz: Should you file for bankruptcy?") But if you can't pay your bills, you should at least explore the other possibilities: forbearance, credit counseling or even debt settlement.


Finally, if you have any of these five black marks on your record, remember two things: The impact on your score may differ from what's shown above, and regardless of how many points you lost, you can rebuild your FICO score over time.

You can buy your Equifax or TransUnion FICO score from MyFICO.com. (Experian no longer sells FICO scores to consumers, although it continues to sell the scores to lenders.) With paid scores, you'll get specific advice about how to improve your numbers.

myFICO May Sale - Save 20% on FICO scores & credit reports




In general, when you're trying to build a credit score, you should:


1. Pay your bills on time, all the time.

2. Reduce your credit utilization; below 30% is good, below 10% is better.

3. Have a mix of credit on your reports, including installment loans (mortgages, auto loans and personal loans) and revolving accounts (credit cards and lines of credit).

4. Refrain from closing accounts.

5. Apply for new credit sparingly.


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Confessions of a Credit Card Telemarketer

by Bob Sullivan

What if there were a way to have your credit card debt erased if you lost your job or became disabled? That's the pitch behind debt cancellation, a service offered by many credit card issuers and retailers.

Debt cancellation doesn’t come cheap: it costs between $1 and $2 per $100 balance. A consumer with a $3,000 balance, for example, could pay nearly $60 a month for debt cancellation service.

That might not sound like such a great deal, but thousands of consumers sign up anyway. Why? One telemarketer who sells the service told msnbc.com recently that there’s only one reason: Sellers intentionally confuse cardholders about the programs and their costs.

"I hate flat-out lying to someone, but that's exactly what we do, 150 calls a day," said the telemarketer, who requested anonymity out of fear of losing his job. "I have seen so many people ripped off that I had to attempt to let people know."

He works in tiny Pennington Gap, Va., a small Appalachian town near the Kentucky border that’s been hit hard by the economic downturn. But he works for some of the biggest firms in America. For the past year, the telemarketer has sold debt cancellation for Macy's retail credit cards issued by Citigroup, working for a third-party firm named Aon Integramark, which contracts work to a local firm, the Kavanaugh CallCenter Group. Aon is one of the world's largest insurance firms, with 37,000 employees and 500 offices in more than 120 countries.

"Are you realizing the power of debt cancellation?" the firm asks of banks and retail stores on its Web site. "These programs provide lending customers with new power and control over their finances -- especially in tough times that can affect anyone."

Quietly, a huge industry

Debt cancellation is a large and profitable business for credit card firms and retailers who issued private-label credit cards. In 2003, the Center for Economic Justice estimated that consumers paid $2.5 billion in fees for such programs, but card firms paid only $125 million in benefits. In other words, the issuers kept nearly 95 percent of the premiums paid.

In standard insurance products, firms pay out about 80 percent of the premiums they collect. The enormous margins in debt cancellation are possible because the programs are not considered insurance and are not regulated as insurance products, thanks to a 1986 Circuit Court ruling.

Few financial products are more profitable than unregulated insurance products, and the bonanza that is debt cancellation (sometimes called debt suspension) have led to aggressive sales techniques for the products. Those have been redoubled during uncertain economic times.

Debt cancellation – and its predecessor, credit insurance -- has a soiled reputation. The Internet is littered with complaints from consumers who say they were signed up for the service and billed hundreds of dollars without their consent.

Read the rest of the article HERE


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The Truth About Free Credit Scores

Though the credit bureaus must give you free annual reports, their important numbers will cost you. Now 3 sites offer free peeks at those scores, but how helpful are they?


If you're curious about your credit scores, you might have tried one of the plethora of Web sites and services that offer some free credit information, then lure you into paying for your scores, usually as part of a credit-monitoring package.
Weird stuff that hurts your credit


Consumers are entitled by law to free credit reports-- which are simply records of your borrowing and repayment history -- but the numerical scores derived from those reports will cost you, in part because credit-reporting agencies aren't required by law to provide them for free to consumers along with the reports.


Now a handful of company Web sites give consumers at least free glimpses at their credit scores. The sites -- Credit.com, Credit Karma and Quizzle -- offer a window into the key factors that go into calculating your scores, what you can do to improve them and how your credit stacks up against other people's. Last week, for example, Credit.com launched free credit report cards that show consumers how they're likely to rate across five credit-scoring models.


All three sites, which have ties to the credit industry, aim to make money through advertising or through fees if users sign up for products offered on the site, such as credit-monitoring services, credit cards or mortgages.

Read the rest of the article here:


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The New Math of FICO Credit Scores

Those with small blemishes on their record should benefit from the FICO 08 scoring change, while high-risk borrowers and those who "piggyback" are the likely losers.

Even the most responsible borrowers slip up sometimes.

Maybe a utility bill went unpaid after you moved and the missed payment went into collections. Or perhaps there are unpaid library fines or parking tickets in collections that are hanging onto your credit history and affecting your FICO credit score, which is widely used.

With the newest version of the FICO credit-scoring system, however, minor delinquencies are now overlooked in calculating creditworthiness.

Under the updated scoring model, called FICO 08, small missed payments lingering in collections with original amounts of $100 or less will no longer do damage to your credit score.

Consumers also are less likely to be penalized for any single delinquency if it occurred two or more years ago -- and if their credit history is otherwise unblemished, says FICO (formerly Fair Isaac), which developed the FICO scoring system.

"There's more flexibility with missing a payment," said Careen Foster, the director of global scoring product management for FICO. "If you have a more habitual pattern of paying accounts late . . . you're more likely to get penalized for that."

If a consumer's credit usage is high, that will be more likely to hurt his or her score with FICO 08. But getting close to your credit-card limits -- even if you always pay on time -- is penalized in some way in every FICO score, not only the recent edition, Foster said.

The changes were made to provide lenders with a better risk assessment of borrowers, said John Ulzheimer, the president of consumer education for Credit.com, a consumer education and advocacy site. FICO decided that one small library fine didn't really predict whether a consumer was likely to default, for example.

With the changes, individuals who pose a low credit risk will probably see their scores rise a bit, and those who are high risk could see their scores drop, he adds.

FICO 08 also addresses "piggybacking," a practice used by credit-repair companies to help people improve their scores, Ulzheimer said. In piggybacking, an individual pays to become an authorized user on a stranger's account. The account holder gets paid for allowing the person to be associated with the account, and the new authorized user is able to improve his or her credit score.

"It was a practice to . . . misrepresent what your credit looks like to your bank," Foster said.

FICO 08 aims to single out individuals who are named as authorized sources through deceptive means, Ulzheimer said. Those people won't see their credit scores rise as a result. But the scores of legitimate authorized users will be treated as they always have been.

Credit Restoration Associates recommends that you still need to be proactive about your credit. By being proactive, you can start to work toward a higher score, something that will serve you well every time you apply for a loan.

Some CRA suggestions:

1. Monitor your credit reports and correct errors. Don't just look for negative events on your record; also examine your credit limits to make sure they're accurate. Credit limits that appear lower on the report than they actually are have the potential to hurt your score.

2. Pay bills on time and keep card balances low. Your payment history, and the amount you owe on your accounts as a ratio of the amount of credit you have access to, are important components of your score. FICO 08 is more sensitive to high credit usage, and consumers may see a lower score if their reported balance on one or more cards is near the account's limit.

3. Take on new credit only when you need it. Some credit cards come with great offers, including a percentage off your bill if you sign up at the cash register. If you accept, make sure you're getting a big enough benefit to make it worthwhile -- taking on additional credit could end up dinging your score.


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What is a debt ratio and why should I care about it?

Your debt ratio is the amount of credit you’ve accumulated on a monthly basis compared to your income.

It’s a critical number if you plan to make any major purchases, such as a home or car, since lenders check your debt ratio to ensure you’re capable of repaying the loan.

Mortgage lenders generally won’t approve your loan if your mortgage payment would exceed 28% of your gross income (before taxes are withheld).

Your total payments -- including all other debts -- should not exceed 36% to qualify for a mortgage.

These debts don’t include food, utilities or taxes.

For these calculations, mortgage lenders look at items like credit card bills, student loans and car loans and how your mortgage would affect your overall ability to pay.


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