| Home buyers and refinancers who've paid all their credit card, mortgage and revolving debts on time could be in for an unexpected bonus: A big jump in their credit scores, opening up the possibility of lower interest rates and fees on future loans.
On the other hand, under important credit-scoring changes now being introduced to major lenders nationwide, some late-paying borrowers can expect painful retribution: significant drops on their scores below where they are today, potentially costing them more money the next time they apply for a mortgage.
These little-publicized credit score changes are part of a new, alternative approach being rolled out by the developer of "FICO" scores, the dominant credit-risk ratings used by mortgage lenders, credit card issuers, auto finance firms, insurance companies, employers and landlords across the country. "FICO" is short for Fair, Isaac & Co., Inc., of San Rafael, California. The company calls the new alternative its "Next Generation" scores, as distinct from the "Classic" FICO scores virtually all lenders currently use to rate loan applicants' risk of future defaults.
The new scores became available from all three national credit repositories -- Equifax, Experian, and TransUnion -- last month, and are expected to be rapidly adopted by banks and mortgage lenders during the coming year. The significance of the move to "Next Generation" scores was explained last week to local credit bureaus at the annual convention of the National Credit Reporting Association in Tucson, Arizona.
The key to the "Next Generation" score is that it uses complex statistical models to "see through" credit file data to better identify loan applicants who represent the highest risks of delinquency or foreclosure. Based on new analyses of tens of millions of consumer credit files, the Next Generation scores "reward" some people -- moving them into the heretofore rarefied "800" and higher score category. But it also pushes other people below the "600" level that often triggers higher interest rates and fees.
Under the FICO score system, consumer credit files are risk-rated on a numerical scale from 300 to about 900. The higher you score, the better credit risk you represent. Late payments, high credit balances against credit limits, too few or too new credit lines, and other factors lower scores. On-time payments, moderate to low credit balances against limits, and active but prudent use of credit over extended periods all tend to increase FICO scores.
Under the "Classic" FICO system now in use nationwide, only 11 percent of borrowers get scores of 800 or higher. Fully 40 percent of the credit-using population have scores of 699 or below. With the introduction of Next Generation scores, however, 22 percent of all borrowers will discover their scores have risen into the select 800-plus category -- double the current proportion. On average, in fact, consumers with relatively clean credit histories are likely to score 15 points higher on the new system than under the current, "Classic" FICO. These are people who manage their credit well, and have no delinquencies or "derogatory" entries on their repository files.
On the other hand, certain borrowers will end up with lower scores:
- Applicants with "thin" credit files that cover short time spans. These tend to be people with one or two lines of credit or who have only recently begun their credit lines. They sometimes score in the 700s under today's FICO system, but will experience a 20-30 point average decline under the new.
- People with serious credit problems -- collections, charge-offs, and bankruptcies--can expect 10 to 15 point drops with Next Generation scoring. However, other borrowers with less serious problems -- a couple of 30-day late payments spread over several years, for example -- may well get slightly higher scores.
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