This is where FICO comes in. The company created the scoring model used by most lenders. FICO scores generally range from a low of 300 to a high of 850. A high score — along with other financial factors, such as income — can place you in a tier that results in the best lending deals.
FICO periodically updates its scoring model, and the company recently announced it would be releasing two new versions this summer — FICO 10 and FICO 10 T.
The new models will do a better job of identifying good borrowers, said David Shellenberger, FICO’s vice president of scores and predictive analytics.
“Consumers who do a better job of managing their credit are going to be rewarded more with FICO Score 10,” he said.
The significant development involves FICO 10 T, which will take a deeper dive into people’s credit usage. Unlike traditional credit bureau data, this model will look at trends in a consumer’s account balances over 24 months.
“Some people will be helped, some hurt,” said Shellenberger.
FICO estimates 40 million consumers will see a drop in their scores by 20 points or more. But another 40 million could see their scores increase by just as much.
Overall, the FICO 10 models are promising a 10 percent decline in defaults for newly originated bank cards and 9 percent among newly originated auto loans. FICO says lenders could also see as much as a 17 percent drop in defaults for new mortgages.
Here are two examples of how the trending data might impact two consumers.
Consumer No. 1: She consistently pays off her credit cards before the due date and stays well below her available credit limit on a monthly basis. Thirty percent of your credit score is made up of your “credit utilization,” meaning what percentage of your available credit is being used or borrowed. High utilization isn’t good for your score.
During the summer, this consumer goes on vacation and racks up quite a few charges. Although she pays off the card before the next billing cycle, her credit score under older models could still see a temporary decline. Analysis has shown that consumers with scores of 800 or higher use a small percentage of their available credit even month to month.
But FICO 10 T won’t ding her for the occasional times in which her credit usage increases.
In fact, consumers who show they are reversing past problems by paying their bills on time will get a bigger boost because the trending report will indicate this better credit behavior.
“Consumers taking steps to improve their credit picture by keeping balances low over time will likely see their FICO Score 10 T move up,” Shellenberger said.
Consumer No. 2: Although he’s paying his bills on time, he has racked up credit card debt. He takes out a consolidation loan and pays off the cards. But soon after, he’s right back in debt on the credit cards. He may apply for another personal loan or transfer the balances to a new card to again help manage the debt. It’s all too much, and he starts to make some late payments.
The data shows people who exhibit that type of behavior are much more likely to eventually have their debts written off as uncollectible, Shellenberger said.
“I especially like the addition of trended data. It makes sense to take these new variables into account,” said Ted Rossman, industry analyst for CreditCards.com. “Of course, if the opposite is true and you used to be responsible but now you’re running up high balances and late payments, then trended data will reflect more negatively upon you. I think that’s fair.”
I think so, too.
People often ask me whether they should get a consolidation loan to pay off their credit cards. Or should they tap the equity in their homes to pay down debt?
My first question to them is: What’s different?
Because if you haven’t changed reckless spending habits, getting a personal loan to clear away other debt isn’t a long-term solution. You’ll just end up racking up additional debt.
Or, I’ve worked with folks who have pretty good credit scores even with a few late payments in their past. But they are struggling — unable to save for an emergency or retirement — because too much of their income goes to servicing debt.
If FICO’s new scoring models can spot people in a financial crisis even before they realize they’re in jeopardy and prevent them from taking on more debt, that’s a good thing.
Have a question about retirement or personal finance? Join Michelle for an online Q&A every Thursday at 12 p.m. Eastern time. Readers may write to Michelle Singletary at The Washington Post, 1301 K St. NW, Washington, D.C. 20071 or email@example.com. To read previous Color of Money columns, go to http://wapo.st/michelle-singletary.