How FICO's New Formula Could Affect Your Credit Score
Millions of Americans make decisions each day (Which house can I afford to buy? How much can I spend? Should I lease a new car?), and they're all based on one single number: their credit score. Our FICO credit score is a measure of consumer risk, and it impacts whether or not a landlord will rent you an apartment, as well as how willing lenders will be to offer a low mortgage rate or a credit card with a low interest rate and other perks. The number is devised by FICO, a public company based in San Jose, Calif., and it is a fixture of consumer lending in the U.S. As consumers, we can check our score, and we know what financial behaviours can affect it, but we have little insight into the actual FICO score algorithm or formula.
When we heard that a new FICO formulation would soon be rolling out, we were curious to learn how the change could affect our own scores. Would it help us or hurt us? Is there anything we can do about it? We spoke with Jonathan Roisman of independent consumer advocacy resource NextAdvisor, to hear what we can expect. Read on below for our interview.
DOMAINE: When will new formulation go into effect? Or is it already in effect?
Jonathan Roisman: It’s currently in the pilot phase, and there has been no official announcement when the score will be available to the general population.
D: How does the new FICO formulation differ from the old one?
JR: The new FICO formulation is designed for people who have bad credit because of a negative financial event (such a bankruptcy or foreclosure) or no credit history. These new scores are aimed to help these individuals gain the ability to receive a loan or credit card from a traditional source. Unlike the old FICO score—which is generated based on your history of paying back loans, credit cards, and other debt-related options—this new score instead uses alternative data to create a credit score for the credit-less consumers.
The most commonly used data will be repayments on cable, phone, and utility bills reported by Equifax and LexisNexis. This new score will range from 300 to 850, just like a standard FICO score. More than a dozen of the largest lenders will have access to this new score and will better be able to determine whether to give a loan to someone with limited credit history—an opportunity these borrowers wouldn’t have without it. It should also be noted that people won’t be able to see this history or score on their credit reports, and it won’t be applied to people who already have a lengthy credit history.
D: Why was the formulation changed?
JR: The change was made to allow more Americans to qualify for credit. More than 50 million Americans don’t have credit scores, which makes it difficult or impossible for them to apply for credit, whether it’s a credit card or auto or home loan. However, many of the people who don’t have credit scores still pay their bills on a recurring basis. A lot of these individuals have cable and cell phone bills every month that, up until now, they haven’t been able to get any kudos for regularly paying. Now people will better be able to qualify for more traditional loans without having a long credit history.
D: Who will this impact? And how, specifically, will this impact Millennials?
JR: Although this alternative score can potentially impact close to 53 million Americans, it’s yet to be seen how many people will take advantage of the loosening of the ability to earn a credit score.
There’s no data out right now on how this will specifically impact Millennials. That said, it will allow younger Americans who are debt averse, but who still have monthly cell phone or cable bills, to prove their creditworthiness. It also effectively makes getting a credit card easier, which in the long run might be detrimental if millions of people who didn’t have credit scores before begin defaulting on their new loans.
D: What, if any, actions should people take once the formula is in effect?
JR: Like with any form of debt, it’s important to repay it either in full or in accordance with the terms of your repayment agreement and on time. This new score has the ability to help millions of people, but it can also easily hurt them if they don’t take their bills seriously. By paying your bills on time, you’re showing lenders that you are worthy of taking a risk on, which is especially important for anyone who needs a loan.
D: Does the new FICO formulation offer any new opportunities?
JR: This is a new opportunity for those who have no or bad credit history to better earn the ability to prove their credit worthiness. With that said, people with a long-standing credit history probably won’t see any extra benefits of paying their phone and cable bills on time. If a bill is sent to collections, however, it will impact both groups—those with or without a long credit history.
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