By JOSH EWERS firstname.lastname@example.org, writer
Big changes are coming to how one’s credit score is calculated, particularly when it comes to applying for a credit card.
The changes will be good news for some.
“The reason is they have not really updated this formula in a long time,” said Brian Davis, assistant vice president and district manager for The State Bank of Williams County. “When the credit scoring model was developed years ago more people were owning homes and less were renting. People’s spending and financial habits have changed, but the formula has not. It’s just a matter of modernization.”
“Trended data” will soon be utilized in an attempt to make the score more fair for a larger number of individuals. Medical collections, tax liens and civil judgments are also being de-emphasized. Additionally, the ratio between a person’s credit limit and their total debt will now come into play in a different way.
The changes are being implemented later this year by VantageScore, which was introduced in 2006 and developed by the three credit-reporting companies. VantageScore determined approval or denial for 8 billion credit accounts last year.
The new credit score calculation method will affect people applying for credit cards and not those applying for mortgages since VantageScore is not used by mortgage lenders.
But what does all that mean?
The use of trended data to calculate the score essentially means that credit rating firms will now look at an applicant’s month-to-month habits more specifically. Under this change, an individual who is paying their debt down will be scored better than someone making minimum monthly payments, but accumulating debt.
For this reason, the Associated Press says people with high credit scores are likely to be more affected, as one of the rationales for the change is to allow for a better warning system for borrowers.
The second change aims for better fairness to those with medical bills and civil judgments.
“The biggest factor in making the change is to de-emphasize small medical collections,” said Mike Ebbeskotte, credit administration manager with State Bank. “Everything that goes into a credit score is proprietary information, so it’s kind of a black box. They spit a score out.
“The government recognizes that collections have a negative impact and given the cost of health care and insurance, the number of people who are insured, they want to de-emphasize that … For people who have never missed payments, they want to make sure they’re being treated fairly.”
The medical collection change was negotiated between attorney generals from 31 states and the major credit bureaus. Barring any delinquencies on an individual’s report, this particular change could bring scores up by as much as 20 points, according to an AP report.
A third change will draw a line in the sand between cautious borrowers and those with the potential to build debt quickly.
Previously, the portion of available credit used was a factor in one’s credit score. Therefore a person with $5,000 in credit card debt with a $50,000 limit from several cards might score better than an individual with $2,000 in debt on a $10,000 limit. The changes will help the latter individual.
“Somebody that has $50,000 available to them, that customer could acquire a lot of debt overnight. Looking at that proportion might skew their numbers a little bit,” said Ebbeskotte. “They’re trying to equalize it a little so that having less available and using more isn’t as bad a thing.”
According to the Associated Press, for this reason, keeping open accounts for the long term may no longer be an advisable score-building strategy and consumers with prime scores as well as anyone who frequently angles for rewards points would be most affected.
The changes shouldn’t be met with panic when they go into effect later this year, no matter one’s credit situation.
“I’ve seen estimates where it may change people’s scores by 10 points, and when you’re working with credit scores that’s not a drastic shift,” Ebbeskotte said. “It may be enough to move someone to a lower interest rate.”
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