Fair Isaac recently informed plans to change its credit scoring formula to ensure the continued reliability and predictive powers of FICO scores. The new model, named "FICO 08" has been making its way into the credit scoring process since late 2008. The model replicates the existing FICO model, which has remained relatively unchanged since the 1980s.
Essentially, FICO 08 will be more forgiving to periodic late payments as long as other credit remains strong, and will have a larger negative impact on your score if you have multiple late payment accounts.
Calculating FICO Scores
A quick summary on the FICO scoring model calculates creditworthiness based on information in five dimensions:
35% of Score: Payment History. Account payment information for credit cards, lenders, and retailers. Use to measure your ability to pay your bills on time.
30% of Score: Amounts Owed. The total amount of credit you have outstanding relative to the maximum amount creditors are willing to extend to you.
15% of Score: Length of Credit History. A measure of the length of time your accounts have been open with creditors and lenders.
10% of Score: New Credit. The number of times you've applied for credit in the recent past.
10% of Score: Types of Credit. This is the diversity of credit you have in your portfolio.
Changes Planned in FICO 08
The primary reason for the switch to FICO 08 had do with the forecasting powers of the new model. Fair Isaac believes that FICO 08 will do a better job at predicting the likelihood of default on a loan by making two changes to its existing model:
Authorized Users – An authorized user is a person that is allowed by another account holder to use their account. Normally, this situation applies to a family member who is trying to manage credit for the first time, such as a college student. The new scoring model eliminates "piggybacking" which allowed individuals with bad credit to leverage the payment histories of "stronger" credit card holders by becoming an authorized user on their accounts.
Delinquencies – The second change in the scoring model has to do with payment patterns – especially those that are greater than 90 days late in making a payment. The FICO 08 model will be more forgiving to consumers that are in arrears in one area, but have a number of other accounts that are in good standing.
Fair Isaac preceds the above two changes will reduce the default rates on consumer debt by 5 to 15% for those companies switching to the new model.
How will FICO 08 affect your credit score?
Keep in mind that credit scores are used by many lenders to determine the amount of credit to extend a borrower. These creditworthiness thresholds are usually based on predetermined bands of credit scores. To make it easier for lenders to adopt FICO 08, the new scoring model will retain the same numerical range (300 – 850), minimum scanning criteria, and parameters as the prior model.
Credit Score Examples
The following examples help illustrate the rules-of-thumb that apply to FICO 08, and how this model may change individual credit scores:
If you have at least one major account in delinquency, but you also have a number of accounts in good standing with creditors, then your credit score would likely increase / improve with the new model.
If you have at least one major account in delinquency, and you demonstrate a poor payment pattern with several other accounts with creditors, then your credit score would likely decrease / deteriorate with the FICO 08 model.
The consumers may experience a 20 to 25 point adjustment to their credit scores where the above situations apply. The most effective way to improve your credit score is by ensuring the information used to generate the score is accurate. This includes obtaining a copy of your credit report and looking for errors.