FICO 08: What the new credit scoring model means to students

By StudentPlatinum.com

A credit scoring system was implemented in early 2008 which hurt an estimated 60 to 75 million consumers, many of them students. The credit scoring system is called "FICO 08" and changed the way Fico Credit Scores are calculated. The FICO credit scoring system is produced by the Fair Isaac Corporation and used by Experian, Equifax and TransUnion to deliver a score to which represents your financial risk to potential lenders. The changes are certainly controversial and have affected almost everybody regardless of their credit history.

What is a FICO Credit Score?

Your FICO Score or credit score is perhaps the most important score you will ever have. Sure ACT, SAT and GMAT scores are important but your FICO score will follow you for the rest of your life while the others become distant and irrelevant memories. Like your ACT, SAT and GMAT scores your credit score is used to tell those who don't personally know you how likely you are to succeed, in this case financially. I like a low SAT score might keep you from a college of your choice, a low credit score may keep you out of the car you really want or from being able to get a home or credit card.

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Whether you know it or not, your credit report starts compiling when you turn 18. Its contents are summarized by a number between 300 and 850 which is your credit score. The longer your history, the less any one individual item will affect your score. For this reason students are a high risk for messing up their credit because there isn't much history to offset even a small mistake. If you don't know your credit score you should definitely find out because you can't fix what you don't know is broken.

Why is the FICO Credit Scoring System Changing?

There are several reasons why Fair Isaac decided to redesign the formula used to generate FICO scores. One big reason is in response to the mortgage crisis the economy is in right now. You see during the real estate boom of the last few years many lenders were overly aggressive in handing out mortgage loans to people who could not pay them back. They made the mistake of looking almost entirely at a borrower's credit score rather than reviewing details such as an applicant's credit report, credit history, income, debt to income ratio, etc.

Because credit scores can be manipulated using loopholes, many people got in over their heads and are now defaulting on loans. Is it Fair Isaac's fault? Not really, if the lenders had been more thorough they wouldn't have put themselves in peril. Regardless, Fair Isaac is getting their share of the blame. In response they are changing the way credit is scored to close some of these loopholes such as authorized user credit cards.

Summary of FICO 08 Credit Score Changes

• Applying for new credit accounts may hurt less.
• Having high balances on your credit cards could hurt more.
• Actively using the credit accounts you have may be more important.
• Having both revolving and installment accounts on your report could help you more, the FICO 08 is more sensitive to your experience with different types of credit.
• No more piggybacking to build credit (cosigner accounts can still build credit)

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Many FICO 08 Changes Will Hurt Many Students

Authorized user credit cards are cards you may have which are in someone else's name, but you are an authorized user. The loophole is that the credit rating of the card holder would reflect upon you raising your score. With FICO 08 this benefit will no longer report on your file. Lenders got really upset for good reason over this loophole. There are a millions of people making use of this loophole and even companies "renting" out good credit ratings by matching someone with a bad credit score with someone who allows that person to just become an authorized user "on paper."

For students who are on a parent's credit card, your credit score is very likely to suddenly drop once your parent's credit is factored out. Spouses of primary card holders are also at high risk. Anybody who is getting a credit score boost by piggybacking should get their own cards immediately! The reason is that after your score drops it will be hard to get credit cards and thus even harder to build your own credit. For students who wish to continue getting the benefit of the credit rating, while piggybacking off someone else's file, you'll now need to become an actual supplemental card holder. In other words, your name needs to be on the legal documents.

Experts estimate FICO 08 changes will drop 30% of consumer credit scores, roughly 60 to 75 million!

Other areas where students may get hurt with FICO 08:

• High balances: now your score will now be much more sensitive to the balances you carry.
• Unused cards: The FICO score is also now more aware if a card has been at a zero balance for some time and will lower the importance of the impact from that card on your score.
• History of delinquencies: If you are late regularly on payments your score will be weighed down even more from now on.
• Mix of credit types: It's now even more important than ever to have a mix of credit types. Basically they want to see more than just school loans or just credit cards. Having a credit card, school loan and a car loan for example is a good mix. Most students won't have an ideal mix because they are just starting out.

Some FICO 08 Changes Can Help Students

Not all the changes with FICO 08 are necessarily bad. Many people will find they are penalized less for "mistakes" as the scores will become more sensitive to repeat offenders. Some of the benefits include:

• 90-day delinquencies: There will now be a difference if your $45 cell phone bill is overdue compared to your $10,000 loan payment. If you had to make a choice and you paid the more serious of the debts that is at least more responsible than not paying any of them. The old method of calculation damaged your score equally for missing either payment.
• New applications for credit: Your credit score won't be as sensitive, or negative, on new credit applications. This means applying for a few credit cards to see which you will be approved for won't hurt you as much as it used to. We've heard that in the past your credit score could drop as much as 20 points per application and last for year!
• One late payment won't kill your credit score anymore: The formula used to be that someone with no late payments on their credit report who made a mistake (had a check actually get lost in the mail) causing them to be one month late, had their score drop up to 100 points. That will no longer be as punitive as the score looks more at the big picture, and becomes a little more forgiving of a one-time mistake.

What to expect from FICO 08 Next

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Although Fair Isaac claims the new credit scoring formula will only affect 30% of credit consumers, the financial industry estimates the percentage of consumers affected will be much higher which means even more than the estimated 60 to 75 million consumers could be impacted. A drastic drop in credit scores for such a substantial segment of our population could seriously damage an already stressed economy. This thought has caused many experts in the business and financial sectors to predict that FICO 08 will never happen. On the other hand, it appears that the changes are already being implemented by some of the credit reporting agencies, notably Experian thus uncertainty is the only thing that is certain concerning the implementation of FICO 08.

What Students Can Do about FICO 08

So what does all of this mean for you as a student and new credit consumer? It means that you need to become more credit aware and increase your credit IQ so you can make informed decisions.

Regardless of what happens, your focus as a credit consumer should be on keeping balances low, paying on time every time, keeping new accounts to a minimum, and limiting the number of new credit inquiries made on your account. You should also consider the following activities without delay:

1. Establish your own student credit card account before your credit score drops and you are unable to get a credit card and build your credit history.
2. Find out your credit score and monitor it for changes regularly.
3. Apply for private and colsolidation loans ASAP before your score drops and you no longer qualify.

 

For more credit card education topics, best student credit card reviews or to use our Customized Credit Card finder, please visit www.studentplatinum.com. If you have more question please feel free to fisit the Student Credit Forum.

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