Improve Your Credit Score Under the New FICO Scoring
April 25, 2009
Improving your credit score before banks check your credit report is an important step towards getting a good rate when applying for a loan, taking out a mortgage, or opening a credit card.
New FICO Score
Fair Isaac, the company that created the FICO score, has been working on a new version of its landmark credit scoring method that might have serious consequences for you if you’re planning on borrowing for a home or establishing any other new credit this year.
Lower Your Balances, Improve Your Credit
The new version of FICO is going to be particularly focused on your balances, not only on your on-time payment records. Your top priority under this new system: Get those balances down.
Reports say that the new FICO revision will actually allow a bit of lenience on late payment – something that might affect more than a few consumers with the downturn in the economy. Obviously, this won’t mean that someone can chronically pay late, but once or twice won’t make the same impact as in earlier FICO versions.
Check Your Credit Usage
Credit utilization – essentially the amount of credit you’re actually using relative to your credit limit – is a much bigger deal simply because high balances are so prevalent right now. From the lender’s perspective, high balances mixed with a tough economy means a higher risk of default among customers.
So what’s a good target utilization rate for all your revolving credit accounts? No more than 50 percent of your credit limit, and if you can get it significantly lower than that over time, that’s a good plan. So, the lower your credit utilization, the better your score.
Repairing Your Credit
What does that mean for ordinary Americans who don’t meet that under-50 percent goal? It means you shouldn’t be applying for new credit or refinancing for awhile. But because most lending institutions may continue their strict lending requirements, you might as well defer borrowing goals in favor of reforming your credit behavior.
Why not use the current environment to launch a credit makeover that will position you for a better shot six months to a year from now? Some ideas:
Good Credit Score: You’ll often hear that credit scores of 700 and up will get you best customer status with lenders. You should aim higher. For the lowest rates and best terms, you need to get your credit score above 740 (the top credit score, by the way, is 850), so keep that target in mind.
Budget: If you’ve never reviewed your spending and picked out areas where you can cut, you’ve never done a budget. Start tracking your spending either on paper or with financial planning software and start pinpointing what spending you can shift over to paying off debt.
Reduce Balances: Get all your non-deductible debt under 50 percent of your credit line in each account. Go after your balances with the highest interest rates first, and once you hit 50 percent…keep trying and get those balances down further.
Debt Reduction Advice: It might not be a bad time to sit down with a tax professional or a financial adviser to talk about the way you’re going to manage your debt going forward.
Free Credit Reports: Remember that you have the right to get all three of your credit reports — from Experian, TransUnion and Equifax — once a year for free. You can do so by ordering them at Annual Credit Report.
Don’t order all three of them at the same time, though. By staggering receipt of each of your credit reports, you’ll get a continuous picture of how your credit picture looks because the three bureaus feed each other the latest information. You’ll also be able to clean up errors as you find them — errors can drag down a credit score – and you’ll also keep an eye out for identity theft.
Oh, and by the way, keep in mind that all “free” credit report sites are not free – if they ask you for a credit card number, then it’s just a free trial that you’ll need to cancel before you’re billed.
Pay on Time, Pay Above Minimum: Yes, we indicated above that you might get a bit of a break on late payments with the new FICO system, but that’s a break you should consider only in a dire emergency. Electronic bill payment will allow you to save on postage while guaranteeing on-time postage, and the budgeting advice mentioned above will allow you to put a few more bucks toward getting that loan or credit card bill paid off.
Don’t Close the Account: In the world of credit scoring, closing accounts (even those that have not had balances for years) is a lousy idea. Lenders want to see a long record of credit management, and longtime accounts that you haven’t touched in years may actually help your score because it shows you have some restraint.
This article on improving your credit score is produced in association with the Financial Planning Association (FPA), the leadership and advocacy organization connecting those who provide, support and benefit from professional financial planning.
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