FICO is the source most lenders use to determine a borrower’s credit score. FICO uses an extensive formula intended to assist financial organizations with making high-volume, complex financial decisions. However, FICO recently announced a new formula called FICO Score 9. Unlike the current model, FICO 9 will remove collection agency accounts which were settled or paid in full. The new formula also distinguishes between medical debt and other forms of unpaid debt.
Many consumer advocates suggest this new formula will provide a fairness to lending decisions which is long overdue. Additionally, the advocates commend the change and praise its efforts. It is important to note that more than 75 million people in the United States have acquired some form of debt. This is debt which is currently in collection on an up-to-date credit report.
Benefits of FICO 9
FICO scores generally range from 350 to 850. The scores are calculated using the payment information offered by the three main credit reporting bureaus. TransUnion, Equifax, and Experian provide credit scores used to determine eligibility for credit cards, automobile loans, and other types of consumer loans.
The FICO 9 formula attempts to apply the concept that as consumer behaviors change, credit scores must change. For example, since 2009, credit card balances have decreased considerably and delinquencies on loans have fallen. Paying debt that is in collection marks a change in the consumers risk level. FICO 9 understands that the credit score needs to reflect this. Although the risk was apparent before, the current risk is not as relevant and this is a result of a behavioral change.
The new FICO 9 credit score formula plans to improve the scores of consumers with medical debts or consumers who have paid off other debts. However, consumers with unpaid debts on their report which are not healthcare related will witness a drop in their credit scores. This will make it more difficult to obtain a credit card or personal loan. In some cases, this will raise interest rates for millions of consumers.
For that reason, it is important to note that the new FICO 9 formula will potentially affect millions of consumers. Although the formula has several benefits, consumers will not witness the changes in credit immediately. The new credit score is expected to become available to lenders toward the end of the year. Additionally, lenders generally take months to apply new scoring formulas to existing loan portfolios. While waiting for the benefits to begin, there are a few aspects of FICO 9 most consumers should attempt to understand.
FICO will not decide FICO 9 availability.
FICO does not sell their scores and as a result they are unable to control availability. Many credible sources suggest FICO 9 scores will become available late Fall 2014 or early 2015. It is important to remember that the three major credit bureaus sell FICO scores and the software is installed on the bureau mainframes. For that reason, the availability of FICO 9 scores is based on the relevant credit bureau.
There is more than one score.
FICO 9 is a combination of credit scores, rather than one all-encompassing credit score. There are four different versions of the FICO score. These versions include a generic FICO score, FICO Auto, FICO Mortgage, and FICO Bankcard. Each of the credit bureaus use a distinct combination of FICO scores each time. Therefore, it will be 12 new FICO scores. i.e. 3 credit bureaus x 4 new scores = 12 new FICO scores
Zero balance collections are ignored.
The FICO 9 score will ignore any collections that have a zero balance. The FICO press release states that any “paid” collections will be ignored. Additionally, collections that have been settled will also be ignored. According to the FICO press release, all collections with a zero balance will be ignored. For some consumers, this acts as an incentive to settle or pay all collections.
Collections remain on credit report.
Collections which currently have a zero balance are ignored by the new FICO 9 formula. However, ignored collections will remain on the credit report until the seven-year limitation is reached. Although the new scoring formula will ignore the collections, lenders may not. In most cases, lenders will continue to notice any consumer debt that has reached collections. Moreover, lenders may continue to hold consumers accountable and deny credit.
Rental history is reported.
Over the last couple of years, residential rental history has been added to consumer credit reports. Equifax was the first credit bureau to add rental history followed by TransUnion. The addition of rental history is an ideal feature for consumers with no credit or a minor credit history. Paying rent on time can improve credit scores and the credit report will now reflect this improvement. The previous FICO score models, prior to FICO 9, did not include rental history. The new FICO 9 model will include this type of account which will help consumers improve scores.
Scores may vary considerably.
When a FICO score is released using the new FICO 9 model, consumers expect a different score from the previous model. Although the score is different, the consumer still expects the score to remain in a close range. For instance, a consumer with a FICO score of 750 under the previous model expects a slightly higher score under FICO 9. However, in some cases, consumers may witness a considerable difference in scores from previous models and FICO 9.
For instance, a consumer with an exceptional credit report with only a few paid collections less than two years old would have a poor credit score. This is typically under FICO 8 and previous FICO models. Under FICO 9, on the other hand, the consumer could have a significantly higher credit score as a result of the paid collections. For some consumers, the difference in scores will be drastically different. To lenders, this score can paint a completely different picture of the consumer. The score using previous models would suggest the consumer is a high-risk. The new score, under FICO 9, suggests the consumer is a reliable borrower.
The difficulty for FICO is communicating which score is the best representation of the consumer. Although the company has to suggest the newer FICO 9 score is an accurate depiction of the consumer, the score from previous models may help paint a different or more accurate picture.
Overall
The FICO 9 credit score has several benefits for the average consumer. The new formula has the potential to create a fair playing field for lending decisions. This FICO model allows current consumer behavior to reflect current scores. FICO 9 has the ability to change the way lenders view credit history and consumer loans.
