New FICO Credit Score Rating System
In case you haven't heard, Fair Isaac Corp., the company that formulates FICO® scores (the scores that most lending institutions use when assessing the creditworthiness of potential borrowers), is rolling out a new credit scoring system designed to close what it calls a "loophole" in the current system. The new credit score scale will affect millions of FICO credit scores.
What's the loophole in the current FICO credit scoring system?
The loophole involves authorized users on a credit card who engage in "piggybacking," a practice that allows people to benefit from the strong credit histories of other consumers, even — in fact, especially — strangers. Piggybackers add their names as authorized users of a credit card held — and paid off — by someone with a history of paying off his or her credit card bills on time. Paying such bills in a timely manner can help build a strong credit history and, with it, a better credit score, so piggybackers have been able to build better credit histories simply by associating themselves with creditworthy consumers.
Traditionally, most authorized users of credit cards were either the children or the spouse the primary account holder (the person responsible for paying any and all charges to the credit card). In recent years, however, there has been a consumer backlash against the emphasis the credit industry places on credit scores. People with no credit history or bad credit usually receive much higher credit interest rates, which can add another financial burden to people who may already face money problems.
A variety of companies reacted to this backlash by offering the piggybacking service described above. Lending institutions, in turn, objected to these services, claiming that they artificially inflate the credit scores of undeserving credit applicants, which can result in approved loans or credit card accounts that present a greater risk of default or non-payment.
How is FICO closing the loophole in its new credit scoring system?
The new FICO credit scoring system will no longer include authorized user accounts in its formula. Therefore, consumers will no longer receive any benefit from piggybacking on credit card accounts held by a person with a solid credit history.
This change will take time, however. The new FICO credit score scale is being phased in slowly across the three main credit bureaus, TransUnion, Equifax, and Experian. Phase one began in September 2007, when Experian started to install the new formula. TransUnion and Equifax are expected to begin implementing the new version in early 2008. Lenders, the end users of the system, will then need additional time to make the switch to the new credit score scale. Given the time and expense required, some industry experts estimate that it will take at least one to two years for the entire transition to be completed.1
What does the new FICO score mean to you?
If you have bad credit, and you've been piggybacking on others' credit card accounts, you probably won't see an immediate drop in your own credit score as this change rolls out. Once the change is fully in place, though, it will very likely affect your credit score.
Other affected groups are the spouses and children of primary account holders, particularly wives and college students. When two people marry , studies show that the wife is more likely to become an authorized user of her husband's credit card accounts than vice versa.1 As a result, the wife's credit history can virtually disappear, particularly if the usual monthly household accounts — utilities, cable, mortgage, and others — are held in the husband's name. Fortunately, there's an easy way to keep your spouse's credit history active: Change the credit card account (and/or other accounts) to a joint account . This way, both you and your spouse would thereby become responsible for paying off these charges, and on-time payments can benefit both of your credit histories.
As for college kids, parents have typically named them authorized users of their credit cards for two reasons: To give them access to emergency (or other) funds while they're away at school, and to help them establish credit histories. The FICO credit scale change will no longer help your college-bound children build credit histories, but it won't affect their access to your credit card accounts, and, as the parent of such children, you do have a few options:
- You can keep your children as authorized users of your credit card account(s). Your children will then have to start building credit histories on their own.
- You can set up secured credit cards for your children. Secured credit cards can help young adults create credit histories but can also levy higher fees and other penalties for delinquent payments than a normal credit card might.
- Finally, you can buy your children pre-paid credit cards. Unlike secured credit cards, these cards require no minimum dollar amount to open. However, since they pay for purchases using already-deposited funds rather than a line of credit, they don't build credit as well as secured credit cards can.
What's the bottom line?
This revision is the first major change to the FICO credit score scale in ten years, and it will undoubtedly affect hundreds of thousands, if not millions, of consumers as it rolls out across the three credit bureaus. However, people with solid credit histories shouldn't see their FICO scores affected by the new formula. The change appears to be targeted primarily at consumers with poor credit histories who have been taking advantage of the loophole in the old FICO credit scoring system.
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