FICO Wants Banks to Tell You Your Credit Score
The theory is that by sharing FICO information with customers, banks can regain some of the consumer trust they lost during the financial crisis, when the predatory practices used by lenders came to the attention of the general public. Shon Dellinger, who runs the FICO division that sells credit scores, estimates that just 5% of consumers have unencumbered access to their FICO score; he thinks that number could increase to 75% if the top 10 financial institutions made scores available.
Why should that matter to you? The results of a 2008 study done by the bank Washington Mutual in conjunction with the Consumer Federation showed that the average U.S. consumer could reduce their card finance charges by $105 annually if they raised their score by 30 points. If all consumers raised their scores by 30 points, total annual consumer savings would be an estimated $28 billion. Given that credit card interest rates were raised dramatically in 2009 as issuers rushed to change rates before the consumer-protecting Credit CARD Act went into effect, the potential savings are likely now even greater. At the time it conducted the study, Washington Mutual did give its credit card customers their credit scores monthly, but Chase (JPM) ended the practice when it took over the bank later that year.
FICO Basics: There's More Than One "Score"
The good news is that you don't have to wait for your bank to agree to release your credit score. You can get your score monthly for free at CreditKarma.com.
Unfortunately, the score you will get is just one of many different types of credit scores lenders could use to determine whether or not you get a loan and how high your interest rate will be. In actuality, there are at least six different FICO scores, plus other types of scoring models that lenders can use, but FICO is the most commonly used.
Each of the three credit reporting agencies has its own version of the credit score, tweaked with a proprietary mix of variables, to determine whether you're a good credit risk. In addition to those three traditional FICO scores, Fair Isaac is also testing NextGen, which it says is an improved version of credit scoring. Then to add to the mix VantageScore, which the three credit bureaus started to compete with FICO. Finally, other independent scoring firms develop scores for individual banks or other lenders, based on criteria that their clients provide.
Not all credit scores focus on credit risks. Some scores try to predict the likelihood that a consumer will file bankruptcy. Others focus on key factors that insurance companies have determined reflect whether individuals are more likely to file claims. Some employers check a job applicants' credit scores before offering them positions.
Better to Have More Credit and Use Less (But Not None)
So what goes into a FICO credit score? There are many variables to a score, and the scoring companies keep the actual algorithms a closely guarded secret, but some basics are known. Payment history and the amounts you owe account for about 65% of the score. Other factors include your types of credit, the age of your credit, and your credit history.
That's why you can quickly increase your score by making two basic changes: Pay all your bills on time and keep your credit utilization low. For example, if you have $10,000 available credit and use less than 30% of it, you are likely to increase your score. Experts' opinions do vary on this topic, but most agree that a credit utilization range of 10% to 20% gives people the best credit scores. If you don't use credit at all, you actually lower your score because you have no credit history.
You can test various scenarios and how they will likely impact your score using the free credit simulator available at Credit Karma. After you sign up for free and get your credit score, check out the simulator and see how various actions, such as applying for new credit or paying late, can impact your score.
When I was researching my book, The Complete Idiot's Guide to Improving Your Credit Score, I used a credit simulator to test various scenarios at FICO. People with long histories of paying on time who suddenly have one or two late payments can see their scores drop by as much as 125 points. In fact, people with good credit scores are more at risk of a major drop in score when their paying habits change. That's because the FICO algorithms consider changes in behavior when predicting credit risk: When a credit customer who has been reliable suddenly doesn't pay on time, his FICO score changes dramatically to warn lenders he could be an increased credit risk.
Your score also will likely take a hit of 25 to 35 points each time you open a new account, but as long as you pay the bills on time, you'll usually regain those lost points in a few months. Still, that's why you should never apply for other credit in the six months before you plan to apply for a mortgage: That's when you want to keep your score at its highest.
Always check your score before applying for a major loan, such as a mortgage or car loan. In today's tight lending environment, your credit score needs to be even higher to get the best rates. I've developed a chart to show you what your credit score needs to be to get the best interest rates: It's posted at WalletPop. I also suggest steps you can take to improve your score before applying for a loan. A better rate can save you tens of thousands of dollars over the life of a home loan.
I hope the banks do decide to make credit scores more easily accessible. Consumers will benefit from knowing their scores and can work on improving them so that they can get the best loan rates. Ultimately, consumers will save billions armed with this new knowledge.