New Threats to Credit Scores

A revised FICO formula will kick in soon, and the balances you carry will matter more than ever. Luckily, little missteps will count less. Plus: How you can protect yourself.

By Liz Pulliam Weston, MSN Money

A long-delayed update to the leading credit scoring formula is rolling out in 2009, offering a few advantages to consumers -- and some serious new risks.

FICO 08, the latest version of the FICO scoring model, was initially supposed to be introduced in the fall but was delayed by lawsuits between its creator, Fair Isaac, and the nation's three main credit bureaus.

Everybody's since made up, and TransUnion will offer the new score to lenders starting in late January, with Equifax introducing it in the spring, said Craig Watts, a Fair Isaac spokesman. (Experian, the third bureau, hasn't yet announced when it will offer the score.)

Fair Isaac says the new score will do a better job of predicting defaults than the classic FICO, which is used in more than 75% of mortgage lending decisions and by 90% of the largest U.S. lenders.

But FICO 08 is even more sensitive than the classic FICO to how much of your available credit you're using. If your credit card issuer slashes your credit limit -- which is increasingly likely these days -- you could see your scores plunge, regardless of whether you carry a balance.

Another hazard: The new scoring formula responds more negatively if consumers have few open, active accounts. Because more credit card issuers are shutting down unused and unprofitable accounts that boosts the chances of damage to your scores.
3 victories for consumers

Not all the news is bad. FICO 08 offers some definite improvements for consumers in several areas, including:

• Collections. The new formula ignores small collection accounts in which the original debt was less than $100. This is a big victory for consumers and one I've advocated for years, because niggling little debts -- created by unpaid library fines, forgotten parking tickets or a small medical bill that slipped through the insurance cracks -- had an outsize impact on people's scores.
• Credit missteps. Fair Isaac says the new version is less punishing to those who have had a serious credit setback, such as a charge-off or repossession, as long as their other active credit accounts are all in good standing.
• Authorized users. Fair Isaac initially said FICO 08 would combat potential fraud by ignoring any "authorized-user" accounts in a borrower's credit report. After a big consumer outcry and potential credit fairness issues, Fair Isaac backed off and decided some authorized-user information would be included.

Adding a spouse or child to your credit card as an authorized user has long been a good way to improve that person's credit score, because your good history with the account typically could be imported to the relative's credit file. But in 2007, credit repair companies began abusing this feature by "renting" authorized-user slots from good credit risks and selling them to strangers who wanted to boost their scores. Some of these strangers bought slots on dozens of different people's cards, boosting their scores by tens or even hundreds of points.

Lenders pressured Fair Isaac to drop authorized-user information from its calculations. But consumer advocates protested, noting that the change could punish millions of innocent parties, including spouses whose entire credit history depended on authorized-user information. Legal experts also warned that ignoring information regarding spouses on authorized credit lines could be a violation of the Equal Credit Opportunity Act.

So now Fair Isaac says the FICO 08 formula will factor in authorized-user accounts "while materially reducing potential impacts to the score," according to the company's FICO 08 marketing brochure. Fair Isaac won't disclose exactly how it does that, but speculation is that the new score will count a limited number of authorized-user accounts and ignore the rest.

Better? Worse?
Fair Isaac made another course change regarding how FICO 08 would handle "inquiries," or applications for credit. At first, the company said applying for new credit would hurt less than in the past, since initial research seemed to show that inquiries had become less predictive of future defaults. Subsequent research, though, contradicted that finding, said Watts, the company spokesman. So you still want to be cautious and apply for credit only when necessary.

But clearly, one of the biggest hazards for consumers is the credit utilization issue. As issuers slash credit limits, the gap narrows between customers' balances and their limits, which is generally bad for their credit scores.

How bad is tough to predict. A limit reduction on a single account won't necessarily trash your credit, Watts said. Because FICO scores assess a lot of data, the effect of a single factor like a credit limit reduction will depend on what other data is on the credit report and how much the line is reduced.

"The person's score could be unchanged; it could go down," Watts said. "Or in some cases, it could go up."

It's fair to say, though, that big reductions in credit limits, and reductions affecting more than one account, aren't going to be good for your scores. Credit card expert Ben Woolsey of CreditCards.com noted that issuers' credit limit reductions so far -- and the promise of more to come -- are "clearly a hazard" to consumers' scores.

Still, Fair Isaac defends the accuracy of its formulas. Watts said the company's research has so far found the credit limit reductions have affected "a relatively small population and those line reductions have been a relatively small amount for a sizable part of that population."

At the same time, he said, a "notable number" of consumers have reduced their use of revolving credit such as credit cards, which is helping to minimize any impact to their FICO scores from credit limit reductions.

"Our most recent performance study," Watts said, "indicates that the FICO score continues to appropriately rank-order consumers based on credit risk."

Different yardsticks, same strategies

Other ways to protect your scores:

• Watch those balances. The less of your credit lines that you use, the better, even if you pay your balances every month. The credit bureaus and your credit scores don't distinguish between balances you pay off and those you carry month to month; the balance that's reported to the bureaus is typically the one that shows on your most recent monthly statement.
  If you're in the habit of using a big portion of your credit limit -- because you travel on business or are chasing credit card rewards -- consider asking for a higher limit or using more than one card. Ideally, you'd use no more than 30% of your available limit at any time during the month; under 10% is even better.
• If your credit card issuer slashes your credit limit, try to get the decision rescinded (read "Thaw out your frozen credit" for details). If that's not possible, use the card less and move at least a portion of your balance to other cards or to an installment loan. For credit scoring purposes, it's better to have small balances on a number of cards than a big balance on a single account.
• Don't close accounts. Fair Isaac has made it clear that closing accounts can never help a classic FICO score and may hurt it. With FICO 08, that's even more true. You get more points for having open accounts in good standing; conversely, having a higher proportion of closed accounts can hurt you more.
• Keep your accounts active. Issuers increasingly are shutting down unused accounts, which reduce your available credit and can hurt your scores. Even if your account isn't closed, though, FICO 08 doesn't like to see a bunch of unused cards -- it wants to see you actively and responsibly using a variety of credit accounts.
• A simple way to keep an account active is to have a monthly bill charged to it, and then arrange for an automatic monthly payment to ensure you don't miss a due date (a single skipped payment can devastate a great credit score).
• Consider an installment loan. There are two main types of credit: revolving accounts that allow you to build up and pay down balances, and installment loans that typically have fixed payments that require you to pay down your balance over time. Credit cards and lines of credit are examples of revolving accounts, while auto loans and mortgages are considered installment loans.

The FICO formula has always rewarded folks who had and successfully managed both types, which is why getting an installment loan was often recommended as a way for people with troubled credit to rehabilitate their scores. The new scoring formula is even more sensitive to the mix of credit types people have and use. In the past, people were able to get and keep very high scores using only credit cards; it's not clear if that will still be true under FICO 08.

Liz Pulliam Weston's latest book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.
Published Dec. 29, 2008

The Truth, The Whole Truth and Maybe Nothing But The Truth!

Maybe it's just here, but lately, I've run into a number of cases of customer fraud. I'm not talking about identity theft. That I can deal with. It's customers who think they can fool me and the bank!

A few examples:

• One customer provides pay stubs on delivery that are over 30 days old. She sends an "updated" pay stub to us after we spot the car... the only problem is the only thing that changed on the pay stub was the date! The dollar amounts were the same as the first pay stub she gave us, but the customer cut and pasted a new date over the original one!
• A customer provides a pay stub on delivery that appears to be legitimate. We package the deal and send it out for funding. The bank does a verification of employment and finds out that the customer is a part-time employee, and the pay stub he provided us is "not consistent with how he gets paid"
• A customer fills out a credit application and tells us he has been at his job for over 6 years. On verification, the bank finds out "Customer was just re-hired at current job 11/24/08 after being gone for years". So much for that approval.
• Three separate cases of fraudulent Social Security numbers, with one customer who could not provide the original card, but had a real good photocopy for us!

It seems as though all the press about the car business being in trouble has got some customers believing that we'll do anything for a deal. I've been approached by customers offering "bonuses" to get their loan approved. Some customers believe that we'll look the other way at indiscretions and questionable activities in order to make a deal. Others are amazed that the banks actually verify everything, and many are dumbfounded by the idea of a customer interview. I constantly have to tell my customers to make sure they answer their phone when the bank calls. Yet I still have to chase customers to get their welcome call done.

One of the things I have done to help cut down on the brain damage is require my sales people to get a "Verification of Employment" form signed by the customer when they complete the credit application. When the customer is reluctant to sign this form, it's a heads up to a potential problem with the deal. In addition, we do a reverse look up on both the home and work numbers provided. Not surprising, we find a lot of cell phones for employers, and either get a proper number, or we don't deliver the vehicle.

It's getting harder to do business these days. Every deal counts, but only when it gets funded. It only makes sense to make sure, up front, that a deal is indeed a deal, and not a repo or rollback!