FICO change benefits many consumers

The company that calculates FICO scores has revamped its scoring system. Many consumers will benefit, but others might have to pay higher interest rates on their next mortgage.

Q. I heard that the company that calculates credit ratings for consumers is changing the way that it puts together its credit scores. Is this true? If so, what are the changes? I am interested because I am planning to shop for a new mortgage after my son graduates from school in June.

A. Yes, Fair Isaac Corp. -- the company that compiles the FICO scores reported by credit bureaus and then used by lenders to determine a potential borrower's creditworthiness -- recently revamped its scoring system.

The changes could result in an increase or decrease of 20 points or more to your score, which in turn could help you easily save more than $500 or $1,000 a year in interest charges if your score improves, but could cost you dearly if the new model pushes your rating lower.

I'm devoting this column to answering some common questions about how the new scoring system will impact consumers, especially those who are planning to buy a house or refinance an existing mortgage.

Q. Why is my FICO score important?

A. It's important because an estimated nine-out-of-10 lenders check it when determining if you should be approved for credit, regardless of whether you're seeking a new mortgage, a car or personal loan, or a credit card. Scores start at 300 and go up to 850: The median score hovers around 720, meaning that half of Americans have a score greater than that and the other half score lower.

The higher the rating, the better. If you have a rating of 760 to 850, you have proven that you have done a sterling job of handling your debt responsibly through the years and will probably continue to do so in the future. As a result, you'll have a good chance of getting a loan at the lowest rate possible because you're less likely to default than someone who has a lower score.

Q. How is Fair Isaac changing its scoring system?

A. One of the most important changes involves a one-time late payment on an account. In the past, just a single bill that went 90 days past its due date could put a serious dent in your FICO score. Under the new rules, failing to make the payment may be reconsidered an "isolated delinquency" if you are in good standing on other accounts and have a credit history of 10 years or more.

For example, let's say you moved a few years ago but your Visa bill went unpaid for 90 days because the post office took too long to forward the monthly statement to your new address. If all of your current accounts are up-to-date, your failure to pay the Visa bill while relocating may be reconsidered by FICO as an isolated delinquency and thus add 10 or even 20 points to your credit score.

Q. I have made my monthly mortgage payments on time for several years, but it bugs me that my FICO score doesn't seem to give me credit for that. What can I do?

A. It seems unfair, but many mortgage lenders don't report a responsible borrower's on-time payments yet are quick to alert the nation's three big credit bureaus -- Experian, TransUnion and Equifax -- if an owner falls behind.

The recent moves by FICO will change that. The company's revamped rules will raise the credit scores of borrowers who have a good mixture of revolving debt, like credit cards, and also have a solid repayment history on their mortgage loans.

Q. I have only one credit card. I have a $7,000 limit on the account and my balance is $6,400. How will the changes affect me?

A. It's kind of goofy, but the new system could result in a reduction of your credit score even if you have made all of your monthly credit-card payments in a timely manner. That's because Fair Isaac considers both the amount of credit you have available and the percentage of credit that you have used: The fact that you have used more than 90 percent of the available credit on your single card ($6,400 divided by $7,000 equals 91) might erroneously suggest that you're not very good at debt-management despite your stellar payment history.

One possible solution would be to apply for a second credit card with, say, another $7,000 limit and then split your $6,400 balance between both cards. This would cut your credit-to-debt ratio in half, a level that many mortgage lenders would find acceptable to OK a new home loan.

Q. Who will benefit most from FICO's changes?

A. The biggest impact will be felt by borrowers who are straddling the line that lenders individually establish to separate one group of borrowers from another.

Let's say that you started the year with a credit score of 695, which many lenders consider to be near the top-end of the "good" or "very good" score bracket.

If the changes boost your rating by a relatively modest 10 points, your new 705 score may catapult you into the "excellent" class and could qualify you for about a one-quarter point reduction in the interest rate on your next mortgage. On a $300,000 fixed-rate loan, FICO says, the lower interest rate would save you about $55 per month or $660 per year.

Conversely, if you began the year with a score of 660 -- which many banks consider to be the lower end of the "good" rating level -- and the changes result in a 10-point drop in your score, you might then fall into a lower rating category and could be required to pay about three-quarters of a point more to get a loan. On that same $300,000 mortgage, the higher rate could cost you an extra $160 per month ($1,920 a year) or more in interest payments.

© 2008, Cowles Syndicate Inc.