First-time homebuyers are often surprised to learn they can qualify for a mortgage, especially if they don’t have great credit. But, changes to the way FICO measures credit scores are set to make it more difficult for many people to qualify. If you’re looking to buy a home this year, or anytime thereafter, here’s what you need to know.
What is the new scoring system?
“Fair Isaac Corp., commonly known as FICO®, has built a new suite of scoring models that will be available from all three credit reporting agencies (Experian, TransUnion and Equifax) to lenders by the end of 2020,” said Experian. “The new models will treat late payments and debt more severely, but will also now consider historical information about your credit card balances and payment amounts. Your FICO® Score will likely change as a result.”
Just how could this impact borrowers? Consumers with high FICO scores who continue to manage their finances well may actually see an increase in their scores. “This change will create greater separation in the 600s,” said Forbes. “If you are in the lower 600s and struggling to make payments on time, there is a chance your score can go down further. If you are in the high 600s and making payments on time and trending toward lower debt levels, your score could actually increase.”
Joanne Gaskin, vice president of scores and analytics at FICO, told NPR that, “About 40 million Americans are likely to see their credit scores drop by 20 points or more, and an equal number should go up by as much.”
What’s NOT changing
The five main factors that FICO has long used in its scoring models will remain. They are: payment history, dollar amount owed, age of credit history, credit mix and new credit accounts. However, the new FICO scoring system “expands into new territory, with the goal of giving lenders a more precise assessment of your credit risk,” said Experian. “It considers your trended data.”
What is trended data?
Trended data offers a closer look at your financial picture over the last 24 months, specifically focusing on how you have managed your existing accounts. Trended data has not typically been shown to lenders for the purpose of qualifying home buyers…until now.
How will this change impact your score
“Those with scores below 600 who continue to miss payments or have blemishes on their credit will see even larger declines in their scores,” said REALTOR Magazine. “FICO…will soon start more harshly penalizing the scores of consumers who have rising debt levels or who fall behind on loan payments. The company will also flag certain consumers who sign up for personal loans, which is a growing area of debt.”
With these new changes, it’s more important than ever to be diligent about protecting your credit. Would-be homebuyers will want to:
Pay your bills on time—This has always been important but is even more critical now. Late payments have always been a red flag for lenders, but they may be even more harshly penalized once the new program is in place. “Delinquencies will hurt scores more” now, said Experian. “The impact of late payments is more pronounced than with prior FICO® Score versions. This means consumers who miss payments are likely to experience a more severe drop in their credit scores” under this new model.
Pay down credit card balances—According to FICO, borrowers should “keep revolving debt below 30% of their available credit so that they don’t see a larger impact to their credit score,” said REALTOR.
Get current—“Pull your credit reports and make sure that nothing has fallen through the cracks like a small medical bill,” said Forbes. “Catching up on those payments may show a positive trend.”
Avoid personal loans—"The scores will weigh personal loans more heavily, the Wall Street Journal reported, in order to penalize borrowers who consolidate debt with personal loans and then go on to rack up more debt,” said MarketWatch.
Don’t cancel your credit cards. Closing accounts can actually hurt your score. “When it comes to credit cards, it can help to hold on to older accounts for a long time,” said NPR. “Doing that gives consumers a more established credit history.”