FICO 08: What It Means To Your Credit Score

FICO has changed its credit scoring formula to a new model, called FICO 08. From all accounts, this new model has been implemented and adopted by the “big three” reporting agencies. As such, many credit issuers have already incorporated FICO 08 into their credit approval process. Let’s take a look at FICO 08 and how it could affect you.

The FICO scoring system creates a credit score based upon five factors of creditworthiness:

Payment History. This is 35% of the total score and reflects payment information for credit cards, lenders, and retailers. In essence, it measures whether or not you pay your bills on time.

Outstanding Balance. This is 30% of the total score and reflects the total amount of credit you have outstanding relative to the maximum amount creditors are willing to extend to you. In essence, it measures how close you are to being maxed out. This is why you never close a credit card account even when taking out a credit card debt consolidation loan.

Length of Credit History. This is 15% of the total score and reflects the length of time your accounts have been open with creditors and lenders.

New Credit. This represents 10% of the total score and reflects how many times the consumer has applied for credit recently.

Types of Credit. This represents 10% of the total score and reflects whether you have a diverse credit portfolio or not. If you only have credit cards and no other types of credit, it will impact negatively on this portion of the score.

The FICO model is designed to provide a straightforward method to consumers whereby the consumer can readily understand how certain credit decisions impact their overall creditworthiness.

FICO implemented its recent changes in an effort to do a better job at predicting the likelihood of default on a loan by making two changes to its existing model.

“Authorized Users” And “Piggybacking”

An authorized user is a person that is permitted by another account holder to use their account.

Normally, this situation applies to a family member who is trying to manage credit for the first time, such as a college student. However, over the past several years, an industry has developed whereby those with good credit would, for a fee, sign a credit card application and add someone to the account with poor credit. This process was called “piggybacking” and served to boost the credit score of the added person.

The new model eliminates "piggybacking" by limiting the definition of “authorized user” to spouse and children of the main credit card holder.

FICO Is More Forgiving Of Certain Delinquencies

The second change in the scoring model has to do those that are greater than 90 days late in making payments. FICO 08 model is more forgiving to consumers that are delinquent on one account, but have other accounts that are current.

The net of effect of this change is that it should reduce consumer debt default rates by up to 15%.

Now that the FICO 08 model has been adopted by all three credit bureaus, it is inevitable that it will be incorporated into the credit decisions by the major credit issuers.

The new credit scores are the primary means used by lenders to determine the level of credit to approve for the borrower. These creditworthiness standards are usually scores according to pre-determined groupings of credit scores. As such, the FICO 08 makes it easier to adopt FICO 08 by retaining the same 300 - 850 scoring criteria, and parameters as the prior model.

Overall, the changes to the FICO scoring system represent a win for the consumer that generally pays his or her obligations on time but occasionally runs into temporary problems. On the other hand, those with poor credit no longer can rely on “piggybacking” to artificially inflate their credit rating.