You know how the credit crisis and recession have battered important national economic indicators, such as home prices, stock market indexes, and retail sales. But how have they affected one of your key personal economic bellwethers—your credit score?
To find out, we turned to FICO, formerly known as Fair Isaac, the Minneapolis company that invented credit scoring. The recession has thrown a lot of rocks at consumers, including layoffs, reduced credit lines, and tighter credit standards. Consumers, in turn, are taking advantage of loan-modification programs and an increased willingness by lenders to negotiate problem debt. FICO itself, meanwhile, has introduced a new scoring model, FICO 08, which could raise or lower your grade as much as 50 points compared with the previous version, all other things being equal.
Here's how a variety of today's credit events may help or harm your score—sometimes surprisingly—and our advice on how to protect your credit rating.
Perhaps not as much as you might fear. A FICO study of 11 million credit files from April 2008 to October 2008 found little to no negative impact on most scores, including those of people whose credit limits had been cut. Over that time, about 16 percent had small reductions in their credit limits, and a majority of them had no risk trigger (say, late payments, overlimit charges, or collections activity). The median score for this group actually rose slightly, from 768 to 770.
For those who did show risk triggers, the scores dropped slightly in response to other credit-report changes. FICO is working on a follow-up using data through April 2009, which was not available to us at press time.
Don't sweat this, but pay attention to the next item.
It can hurt somewhat if you had a large credit line and a low balance, says Tom Quinn, vice president of global scoring solutions for FICO. That's because the scoring model will no longer include your vast, unused credit from this account when calculating the percentage of total available credit you're using.
If you still maintain a sizable balance on the account, the negative effect is smaller, Quinn says. And if you always thought you got bonus points if you, rather than the lender, shuttered an account, the FICO model doesn't recognize any difference.
Keep the existing account open but use it sparingly if you hate the rate. This is especially important if the credit card happens to be your oldest account, because the scoring model only "knows" your earliest credit experience (for which you get positive points) from what it "sees" in the credit report. Closed accounts are eventually dropped from your report, so the longevity of your credit history will not be apparent, which could hurt you.
It helps by reducing your total credit use as a percentage of your available credit. Paying down balances is one of the most effective ways to improve your credit rating.
Yes, deleverage, but don't go to absolute zero and flatline. "Typically the model wants to see a little bit of credit activity," Quinn says.
If you're trying to boost your credit score to qualify for lower-rate credit in the near future, you should pay off your balances as soon as possible. There can be a lag between the time lenders cash your check and when they actually get around to reporting your payment to the credit bureaus.
The impact will probably be negative, though it depends on your other credit and how the lender reports the transaction. Under a modified loan agreement, your lender will agree to accept a lower amount from you than you committed to repay when you took out the loan. If other bad marks are showing on your credit file, renegotiating a loan might not do much more damage. If this is your only problem and your lender reports the deal as "paid as agreed," the scoring model will never know about this special debt relief. But if a loan modification or short sale (selling the house for less than the mortgage, with the lender accepting the proceeds to pay off the loan) is reported as "in partial payment," "deferred payment," or some other "not paying as agreed," your score could suffer substantial damage, even if that's the only blemish.
Before entering a special payment plan, ask how the lender will report it. If you need help, take the deal sooner rather than later, even if it will hurt your score. That's because as bad information ages, its negative impact on your credit score fades. So acting quickly starts the clock ticking toward that seven-year mark when most negatives must be removed from your file by law. A loan modification is generally less damaging to your score than a foreclosure.
A small negative. The scoring model doesn't know if you've been denied credit, but it will see all the prospective lenders' inquiries. Too many of them may be seen as risky credit-seeking behavior. The actual impact on your score, however, is only a small ding.
Apply for credit in person, and ask the loan officer if the lender's credit standards have been tightened and what your prospects for approval are. If it's questionable whether you'd qualify, find a more lenient lender and apply there instead. If you're loan shopping, do so within a 14- to 30-day period. The FICO model counts all inquiries related to car loans and mortgages that take place within that period as if they were a single inquiry.
Zero. The underwriting terms of the loan, including those that might expose you as a big risk, are not provided to credit bureaus and aren't figured into the FICO score.
Keep making your mortgage payments. If you can, refinance an adjustable-rate mortgage to take advantage of lower rates on fixed loans now.
It's a negative. If you enter into a "partial payment agreement" with a debt-relief firm, it's usually reported to the credit bureaus, dinging your score despite your responsible approach to dealing with too much debt.
If you're struggling to stay afloat, the sooner you get your finances back on track, the better. So don't let the possible effect on your score keep you from seeking such help. After the initial hit, your score will gradually improve as you show responsible borrowing behavior.
A credit counselor can help you set up a five-year repayment plan with more favorable terms. If you go this route, stick with reputable, nonprofit agencies that employ trained and certified counselors who are members of the Association of Independent Consumer Credit Counseling Agencies or the National Foundation for Credit Counseling. Also check the agency's Better Business Bureau report.
A positive. FICO doesn't track changes on your credit file, so if a negative item is removed by a creditor today, the scoring model won't know it ever existed.
It can't hurt to ask a lender to remove a negative, especially if it's the lone smudge on your otherwise good record and you have a longstanding relationship with the creditor. David Coulter, CEO of SmartCredit.com, a site that sells TransUnion credit reports, credit monitoring, and fraud-alert placements for $19.95 a month, says 50 percent of the customers who use his service to ask for a goodwill correction get it. You can contact the lender and do the same thing on your own—free.
It hurts. The FICO model doesn't weigh delinquency of one type of loan any more or less than a missed payment on other types of credit. And even bills that aren't generally reported to credit bureaus—say, a doctor's bill—could eventually show up on your credit report if the unpaid debt is sent to a collection agency.
Don't blow off "less important" creditors. If you can't manage all of your bills, call the creditor before you're late to make payment arrangements.
No impact. "Lenders don't pay any attention to that special-comments field on the credit report," Quinn says, "and our scoring model doesn't either, because that information can't be coded." Even if your file is flagged because you're a victim of identity theft, the FICO model won't adjust your score. But lenders do have special processing for applicants who are victims of ID theft, and credit bureaus have a process for removing fraud-related information. Once that's purged from the file, your score will immediately reflect your accurate credit rating.
Keep the sad tale of your divorce off the credit report but tell it to the loan officer in person. If you're a victim of ID theft, immediately place a security freeze on your credit report at all three credit bureaus (to block access needed by creditors to approve the crook's future loan applications); file a police report; and contact the credit bureaus to begin the process of removing any fraudulent information.
No positive benefit if it's a scam; some gain if you're legitimately authorized to use a spouse's account. Scammers will help you pad your credit score by selling you "authorized user" status on their account, though you never actually use or have access to its credit line. The old FICO scoring model couldn't discern this fraud from a legitimate authorized user, such as a spouse, and gave points for a good payment history as if it were your account. FICO 08 now makes those distinctions.
Never misrepresent your credit profile. But if your spouse has a better credit history than you do, your score can benefit if you become an authorized user of his or her account.
No negative; possibly positive. Whether a loan is covered by credit insurance isn't reported to credit bureaus, so the FICO scoring model won't penalize you for your anxiety. If the safeguard kicks in and the insurer pays your bill, all FICO sees is "paid on time," a plus.
We generally frown on credit insurance. But if it makes you feel better in these worrisome times and you don't pay extra for it, take the deal. But first read the fine print to make sure that loopholes aren't creating false security.
No problem! FICO 08 bypasses collection items under $100. It is also more forgiving for isolated minor delinquencies than the previous version.
Always return your library books on time.
Your FICO score, as you may already know, is derived from data gathered by the three major credit bureaus—Equifax, Experian, and TransUnion. They track, month by month, your lenders, the amounts you owe, your balances, your credit limits, your payment history, and your applications for new credit.
FICO's scoring models distill each credit report into a single number from 300 to 850, the higher, the better. According to FICO, a 50-point difference in a score could cost you an extra $200 on your mortgage. Your FICO score for each credit bureau can vary because of differences in the data collected.
At myFICO.com, you can buy access to your score based on your Equifax or TransUnion credit reports for $15.95 each. But lenders may judge you using different scores generated by FICO models tailored to the credit needs of specific lending products—auto loans, credit cards, mortgages, and finance company credit. FICO also has scoring models to grade subprime borrowers and people with no credit history.
Those scores have a wider range (150 to 950), and you can't buy access to them. While the final numbers may differ, the same scoring principles apply, according to Tom Quinn, vice president of global scoring solutions for FICO. So if you take action to improve your creditworthiness, it should have a positive impact on all your scores.
This article appeared in Consumer Reports Money Adviser.