With a new version of the leading FICO credit score working its way through the lending industry, borrowers who have wrestled with medical debt and others who have only a limited credit history might find their scores have improved when they apply for future credit cards or auto loans.
FICO Score 9 was rolled out last fall by the three major credit bureaus -- Equifax, Experian and TransUnion -- and labeled a more "nuanced" version of the original FICO Score introduced in 1989. It now bypasses collection agency accounts and weighs medical debt differently than non-medical debt on a person's credit record. Borrowers with a median score of 711 whose only negative credit data comes from medical collections will see their credit core go up 25 points under the new system.
The reason medical debt is getting revised treatment in the new system has to do with the idea that most people choose to take out loans and credit card accounts but generally don't choose to take on medical debt, which is typically the result of unpredictable illness or emergency.
It's worth noting the impact of medical debt on American households during the recession of 2007-09. A much-publicized 2009 study by Harvard University and Ohio University researchers pointed out that 62.1 percent of all bankruptcies in 2007 were the result of medical debt, with 92 percent of filers having debts over $5000, or 10 percent of pretax family income.
As for consumers with limited credit histories -- what the industry calls "thin files" -- FICO says the new system will better determine the ability of someone in that category to repay a debt by classifying their repayment behavior based on degrees of risk rather than payment or non-payment in absolute terms.
What doesn't FICO 9 address? Recent reports indicate that consumers hoping for revised credit assessment for mortgage and refinancing opportunities will have to wait for future adjustments. Lenders use credit assessment standards set by Fannie Mae and Freddie Mac, the quasi-government enterprises that provide the secondary market for home mortgages, and mortgage experts say those agencies tend to use older FICO models.
For ordinary borrowers hoping to get better rates on a broader range of loans beyond auto and credit cards, here are tactics to analyze and improve one's credit score over time:
First, it is important to review each of your credit reports once a year. Credit reports and credit scores are two different things. Consider credit scores a shorthand measurement of your creditworthiness; credit reports are the detailed record of your credit history. You can review each of your credit reports from Equifax, Experian and TransUnion once a year for free. It is difficult to have an optimal credit score if your credit reports are not accurate. Also, stagger your credit reports at various points in the year so you can weed out any inconsistencies, inaccuracies, or worse, indications of fraudulent credit or I.D. theft.
Many lenders are now offering the credit scores assigned to you for free. While credit reports are available for free once a year, consumers have had to pay for access to their credit scores through Experian, Equifax and TransUnion. Even then, consumers didn't know whether those scores were actually the ones being used by their lenders. That's starting to change. A few major lenders have taken part in the industry-only FICO Score Open Access Program, which lets current customers see the exact credit scoring data applied to them at no charge. FICO's site doesn't offer the names of participating lenders, but when speaking with a lender, ask if they are offering free scores through the FICO program. If you receive a free credit score from a lender and if you have questions, be sure to follow up.
If you don't know the components of your credit score, here is FICO's breakdown:
- Payment history (35 percent)
- Amounts owed (30 percent)
- Length of credit history (15 percent)
- New credit (10 percent)
- Types of credit used (10 percent)
A February Bankrate.com report noted that approximately one in four Americans have more credit card debt than emergency savings. While savings is not a factor in credit approvals, whittling down debt over time definitely is. FICO has its own official list of things you can do to improve your score, but keep in mind that paying bills on time and keeping balances well below your borrowing limit are the two biggest determinants of a good credit score. Base FICO scores have a 300 to 850 score range, and though FICO doesn't release what it considers good or bad scores, borrowers with excellent credit typically have scores in the mid-700s and up.
If you haven't used a particular credit card in a while, use it to make a small charge that you can pay off immediately -- and then put it away. The idea is to preserve your available credit limits while keeping balances paid off as quickly as possible. Such behavior demonstrates responsible credit use and may lead to an increase in available credit.
One more way to improve your credit score might be to ask if you can raise your credit limits on individual accounts while you keep paying them down. Smart borrowers generally keep their outstanding balances at 30 percent or less of their available credit limit. If you have a good payment history but balances above 30 percent, ask your lender if they will consider raising your credit limit. The lower your debt to credit ratio -- the amount of credit you're actually using -- the better your chances of raising your credit score over time.
Bottom line: Do you know your FICO Score? With a new version of the leading credit scoring system released this past fall, it's even more important to understand how you're managing your credit.
Jason Alderman directs Visa's financial education programs. To follow Practical Money Skills on Twitter: www.twitter.com/PracticalMoney
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