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!

Entitlement or Priviledge?

I am consistently amazed at customers who come in thinking that, despite the fact that their last vehicle was just repo'd, they want to get another loan without putting any money down. It seems that these customer believe that credit is a right, or entitlement, and that regardless of their past credit history, or lack thereof, they shouldn't have to put any money down in order to get a loan.

Well, I've done some research on this matter, and to no one's surprise, the Founding Fathers were very explicit on the rights we bestow on our citizens. Freedom of speech, religion, assembly and such were all spelled out very clearly. But no where in the Constitution could I find a reference to the right to "buy now and pay later".

I tend to believe that credit is a relatively new concept. Folks in colonial America may have had credit arrangements, but they were more likely than not between merchants and customers that knew each other first hand. Long relationships had already been established, and credit, as it was, was limited in depth and term. Small amounts for short terms, until the harvest, or the sale of a horse, or some other transaction would occur, to make good on the debt incurred. It made sense, since there was little mobility in those days, and it wasn't hard to find someone who owed you money. You rode out to their farm and asked for repayment, whether it be cash or collateral didn't matter.

Today, banks lend at more than an arms length from a customer. Few, if any of our customer actually meet the people who are loaning them the money, and so lenders look for some commitment on the part of these customers with regard to the loan. There is no "right" to credit, it is really a privilege that must be earned. Stability and ability are fine attributes in an applicant for a loan, but far too many lenders learned the hard way that, simply because a customer looks like they can afford the payment, that doesn't necessarily mean that they WILL pay them. A commitment to or "customer participation" in the loan won't insure that the payments will be made, but at least the lender knows the customer has a stake in the game. I often tell my customers that their credit challenges can be overcome with a significant commitment on their part to the transaction.

The lack of a satisfactory payment history shouldn't preclude a customer from getting a loan, it just means that they have to prove that they will actually make the payments. For too many years, auto credit was a three strike deal - regular finance, special finance, and last but not least, buy here pay here. Customers knew that they could simply stop paying on their current loan and go down the street and get another car with little problem. Lenders were flush with cash and eager to over extend credit to folks who shouldn't have gotten it. Now we all are paying the price.

There is now guaranteed right to credit. Maybe I need to right the "Credit Challenged Bill of Rights"? Kind of like the Miranda rights you hear on all those cop shows and movies. Hmmm...

What's Does It Take To Be Successful In Subprime?

Yes, it's still about the relationships your dealelrship and you have with your lenders, but the lenders are getting much more cautious with their approvals. More lenders are doing upfront verifications, and even prime lenders are verifying income on some deals. Lenders are looking more closely at DTI issues, and most payments have gone from 20% PTI to 12-15%. Huge advances are also a thing of the past; I haven't seen an approval from a subprime lender over 115% since I've been back here. 110% seems to be the magic number, and even Drive, when they give a 115% advance eat it up in their fee.

I talk to my buyers only when I have something to bring to the deal, or to make sure they have all the correct information to make their decision. Many times, Dealer Track may not transmit all the income info correctly, especially on 2nd income or part time jobs.

My secret has always been to send a lender a deal they can buy. Good business is good for everyone..good for the bank, in that they can collect the loan. Good for the dealership so we sell a unit and make a profit, and good for the customer to get a vehicle they want AND can afford. The days of stuffing a customer into a deal for huge gross profits is a "once upon a time" or "remember when" deal. If I can make $2000 profit, I'm a happy camper. I only wish I could get the huge advances with all the back end products we used to get. But by sending an application structured to the lenders guidelines, I get most of my deals approved first time out. Rehash when I need to, but I don't waste the buyer's time on an unrealistic structure and expectation.

I also maximize my relations by telling the lenders upfront about problems or obstacles they might encounter when it comes to funding a deal. Cell phone bills, landlord verifications, anything that might be a problem for them is expressed upfront so there's no surprise on either end at funding.

Full spectrum lenders? A figment of your imagination, like unicorns or the Loch Ness Monster! No one is buying the "full" range of customers. The only lender I have digging deep is S.E. Toyota, and only on Toyota products. First time buyer programs have pretty much evaporated, with Drive and Summit doing these deals, but with limited advances and payments. Many lenders have increased their minimum criteria, raising income to $1600 or more, minimum 1 year on the job, minimum down payments, etc. "No money down" deals followed the unicorns out of town!

I spend time talking to my buyers and reps about their programs, and what they are looking for, not what I want. I have all the 560 and up lenders I need, the problem is the customer demographics here are way below that. My average FICO score falls below 520, with mid to high 400's the rule rather than the exception.

Foreclosure is a big problem here, and most of my lenders won't approve a customer in foreclosure. Once the foreclosure is over, however, it's open season, and I have some lenders giving decent approvals to these customers. Lately, I've seen a bunch of customers with multiple foreclosures - investors who got in way over their heads and can't get out from under now. Many of these customers knew they have credit problems, but still think they can negotiate the terms of the loans. Many leaved pissed off, only to come back a day or two later, after they realize I was honest with them, but other lenders have already sent the applications everywhere, and it's getting harder and harder to turn a decline around.

I have been talking to many deep lenders, trying to find other sources, but many have limited recourse (first 3 payments or first payment default). I had a few lenders who want us to pay them an upfront fee to sign up with them, and many of the dealer agreements I've looked at appear to be written by Chinese lawyers (lots of print that you can understand).

It'a A Jungle Out Here...and It's Getting Harder to Navigate

The lead story in this week's Automotive News reads "Credit-crunched". That doesn't begin to tell the story!

Almost daily, I'm am harangued by sales people who complain about the deals they used to get done. You know, the ones where the customer can't prove their income, or the ones who only claim to credit fame is a repossession. I constantly remind them that things are different today, that getting proof of income (POI) waived, and getting a marginal customer with a high credit of $300 a $20,000 auto loan is just not happening these days. It's not that I don't want to do the deal, it's that I don't want to deliver a vehicle I know we'll have to take back in a week! Lenders are tougher and tighter these days, and while I have all the 560 and up lenders I can use, I wish there where more of the sub 520 lenders available. And then I have to explain that a higher FICO score doesn't necessarilly mean a an apporval.

Here in south Florida, the problem is probably more acute than other areas. Like California and Las Vegas, we are faced with a mounting foreclosure problem. Customers come to us in the midst of foreclosure and want a newer car, or they want to trade in a vehicle they bought 6 months ago because some sales rep told them they could trade it in after ONLY 6 months. It's hard on everyone when we have to say "No" to a customer. Many Special Finance departments appear to be "Deal Prevention Departments" This is fair from the case.

I believe that most of us doing Special Finance these days have a pretty good handle on what our lenders will buy and fund. Delivering a customer and signing papers takes little talent, the real talent lies in making a profit AND getting the deal funded. The days f jamming a deal down a lenders throat are long gone, and Special Finance managers that don't partner with their lenders will find themselves running short of lenders real quick.

My lenders know that I send them applications they can buy, and my deals go in clean and ready to fund. Maybe that's why I got a lender who had shut this dealership off after they had looked at 62 non-buyable applications the month before I got here to turn us back on. In August we funded three deals with them, and this month 5 more!

Yes it's getting harder to get deals done. Yes, lenders are fewer, and profits are getting leaner. 145% advances...I only wish I could get those on a regular basis. But making lemonade out of lemons is what I get paid for, so...

Good Business Has To Be Good For Everyone

Well, it's been 2 weeks back in the seat. While I'll be the first to admit it's a different world today, I can't really say that it's that much different from what I remember. While there have been a number of lenders leaving the market (HSBC, Triad, UACC) or others that have been retreating or reluctant to expand, the lenders that are left are still buying deals. The only difference these days is that lenders are looking a lot harder at the applications they receive.

Good business has to be good for everyone. That rule has never changed. A deal has to be good for the dealer (there's a profit to be had), the customer (the payment is affordable) and the lender (the loan is collectible). If is doesn't work for any of the players, there's no sense in doing the deal.

The lenders I've spoken to lately all ask me the same question. They want to know how I decide where to send an application. That hasn't changed since I got started in Special Finance. I send the application to the lender I think will buy the deal. I make sure to know each lenders guidelines, and avoid sending an application that I know doesn't meet their basic criteria. If the income is too low, or the score to low, or it lacks the length of employment, I don't send it to a lender who has those criteria. Keeping non-complying applications from lenders that won't buy it keeps look to book in line, and builds credibility with your lenders. It makes it easier to ask for a favor when necessary, because they know you know what you're doing.

Yes, the number of sources has shrunk, and the days of easy credit and no money down are long gone. Yet the customers still expect it. The majority of my day is spent explaining to customers that simply because they look they will pay the loan, lenders know that this does not necessarily mean they will. Making the deal good for everyone is what works today. And that's the thought for today!

Changes in Attitude, Changes in Lattitude!

It's been a while since I've been here, and I apologize to those of you who follow this blog. As you're reading this, I have returned to my roots in South Florida, taking a position with one of my former clients as Director of Special Finance.

After three years outside of the dealership, I decided I needed to go back inside to get a clear understanding of today's market. Everyone has been telling me that things have changed, and indeed they have, but I decided that the only way I could truly understand was to see for myself. Special Finance is a lot like skydiving... everyone knows how it's done, but only those who have actually jumped can tell you what it is like!

So, it is with that thought that I have "jumped" back in to the dealership. I had worked for this company before I decided to move to Charlotte, and when the used car director called me to ask if I knew anyone who was looking to make a move, well, as they say, timing is everything. After some careful consideration ( and a pay plan that was too good to pass up), I headed for the airport and here I am.

I'll be writing here on a regular basis, as well as in Special Finance Magazine. A view, from the front line so to speak, trying to bring a fresh perspective on what is really happening in dealership TODAY! In the meantime, I welcome your insight and comments. Send your thoughts to subrpimecoach@hotmail.com and I publish them here.

It's good to be back. I forgot how much I missed this, and look forward to sharing my stories with you. Until then, remember..."If everybody could do this, they wouldn't call it Special Finance!"