Once upon a time, there was a young couple who saved and saved for their first home. They struggled through years of horrible apartments and barely rolling cars in order to put together a fund to cover their five percent down payment and closing costs, plus a little extra for repairs (just in case). Unfortunately, when these bright young people were just on the verge of having collected enough money for the biggest expense of their lives, they were in a car accident with an uninsured driver and were seriously injured.
Over the next year, the young couple required a series of costly surgeries that ate up the hopeful little savings account and still left them with a glut of unpaid medical bills. Suddenly, all their hopes and dreams were crushed. They were disappointed, hurt, angry and felt like all their sacrifice had been for nothing. When they got a second chance at home ownership via a loan from a family member, it was too late — all the unpaid medical bills were in collections and their credit was destroyed.
Why am I telling you this story? Because it happens every day in America, and the penalty for being the victim of truly bad luck has always been harsh. As credit is an increasingly bigger player in our world, with employers even running credit checks before considering making a job offer, it stands to reason that someone should stand up and make some allowance for circumstances outside of a person’s control.
Luckily, the Fair Isaac Corporation is doing just that — debuting this fall is FICO Score 9. This new and improved method of calculating credit scores is a small step, but it’s a step, toward evening the playing field for credit-worthy borrowers who were blind-sided by medical debt. Over 64.3 million Americans have unpaid medical debt, so there’s a lot riding on this big change in calculations.
What’s in a FICO Score?
Most of the borrowing decisions in the United States, as well as many globally, are made using the applicant’s FICO score. This magic score ranges from 300 to 850, with most home lenders willing to make mortgages above the mid to high 600s. There are five major criteria that are used to calculate this score. Let’s walk through them to better understand how FICO Score 9 is going to shake things up.
Part 1: Payment History. Obviously, it’s important that you pay your bills on time, every time, which is why FICO places the most weight on this category — it makes up about 35 percent of your score. A late pay on secured credit like a mortgage is much more damaging than a late pay on a credit card, but none of them are recommended since your past payment behavior is considered predictive of your future credit management.
Part 2: Credit Utilization. As much as 30 percent of your FICO score is based on how well you handle your credit cards and other credit accounts. Maxing out these accounts makes FICO nervous, so they will tend to penalize you for it. On the other hand, not using your credit at all makes it difficult for FICO to get a read on your borrowing behavior. If you can keep less than a 10 percent balance on your cards at any given time, FICO will love you for it.
Part 3: Credit History Length. Long-term relationships aren’t just good for business and your personal life, they also help FICO better understand your credit behaviors. If you’ve got no credit accounts (or only a few very new ones) this part of the calculation, which accounts for about 15 percent of your score, isn’t going to help you much. The longer you’ve kept and used your credit accounts, the better you’ll score here.
Part 4: New Credit. Applying for too much credit at once can have serious effects on your credit score. Except in special circumstances like applying for multiple mortgages in order to secure the best rate, FICO frowns hard on too much new credit. If most of your accounts are new or you’ve had a lot of inquiries because you’ve been trying to get several new accounts, your new credit score may be in serious trouble — and it makes up 10 percent of your FICO calculation!
Part 5: Credit Mix. FICO likes to see that you can juggle more than one type of credit at a time, so they’re really pleased when they see you’re paying a mortgage, an auto loan, a credit card and store credit lines. Credit mix is weighed the same as new credit, at 10 percent of the score, but it isn’t a requirement for a high-flying FICO.
How FICO Score 9 Will Change Things
FICO Score 9 has been designed to tell the difference between medical and non-medical debt in a collection status, as well as to ignore paid collection items entirely. For mortgage-hopefuls who have little else in the negative besides their massive pile of medical bills, this change will be undeniably positive — FICO predicts the average credit consumer will see a 25 point boost once the algorithm is fully integrated. It doesn’t sound like much, but when it comes to mortgages, sometimes 25 points is all you need to move from subprime lending to an FHA-backed loan.
This new lending model was birthed out of a very serious need for more home buyers. It’s no secret that the real estate market is still running hot and cold, with some areas almost back to normal while many others lag behind because there simply aren’t enough buyers or sellers. Sellers aren’t putting their homes on the market because they don’t think there are any buyers, so qualified buyers aren’t looking at homes, and so forth. Hoping to stop this nasty cycle, FICO looked for credit score-crushing factors that were least likely to predict credit defaults — and the medical bills had it.
Many Americans will win out with the new FICO Score 9, but whether or not the boost in their credit score will be enough to get them back in the real estate market remains to be seen. The lucky masses may instead choose to replace their old car or open a credit card — it’s hard to say at this point.
Although FICO Score 9 is set to roll out this fall, experts think it will take a year or more before these score bumps start to appear in credit files. Of course, if you’re not looking for credit at that point, it probably won’t help you directly, but when you go to sell your home you may have FICO Score 9 to thank for a larger pool of buyers.
That being said, FICO Score 9 is far from a scam to get the media focused on lending again, but it has already had that effect. Borderline borrowers are starting to ponder their creditworthiness and are beginning to consider applying for a mortgage loan in the future. This is how it begins — this could be what recovery really looks like for the American real estate sector.
The Bottom Line: FICO Score 9 is a Winner
No matter who you are, it’s good to have a better credit score. No one has a perfect credit account, and a lot of people have medical bills, so this move can’t be anything but good. We need consumers spending on big ticket items, we need more real estate churning and we need more borrowers to bring enough money back to the market for it to be truly healthy.
Those folks who have been praying for a miracle to save their credit after expensive cancer treatments are going to get their dearest desires, consumer confidence will increase simply from the boost of confidence in the ability to borrow and the American capitalist system may begin running like the greased machine it once was. It’s no secret that it’s going to take everybody working together to really get the economy back on track, FICO Score 9 is just one of the many helpful stepping stones along the way.