Personal finance: Where credit is due
As posted on February 4, 2008 on www.newsday.com
By Tami Luhby
Bob Friedrich always pays his bills on time . . . well, almost always.
Three years ago, he sent in his monthly mortgage payment as usual, but it got lost in the mail. He thought the problem was history after he paid the overdue balance the following month. But when he got his credit report last month, he found the single late payment with a note that it was negatively affecting his credit score. Friedrich, 53, an accountant who lives in Glen Oaks, wasn't happy, even though his score was still an impressive 790 out of 850.
"I think it was improper," said Friedrich, who contested the blemish and hopes it won't appear on future reports, which he checks yearly. "It was a single late payment that wasn't my fault. It was the post office's fault."
Friedrich, however, probably won't have to worry about the late payment affecting his score when he pulls his credit report this coming December. Fair Isaac Co., creator of the widely used FICO credit score, is changing the formula used to determine how likely a borrower is to default on a loan. Rating agencies will likely start putting the new system into effect this spring.
Forgiving isolated stumbles
Under the new system, people who miss an occasional payment or two will not be penalized as much as they have been. On the flip side, those who repeatedly fail to pay debts on time will see their scores tumble.
"This tweak will be more forgiving of isolated credit stumbles that many people fall prey to," said Craig Watts, a Fair Isaacs spokesman. "But if someone is showing a clear pattern of recent delinquencies, their score is likely to fall further."
Your payment history accounts for 35 percent of your score, while another 30 percent is based on the amount you owe. The length of your credit history, the number of new accounts opened and types of credit used make up the rest.
The new system will be more lenient when it comes to applying for additional credit, which now can hurt your score a lot. But it will no longer count credit lines of "authorized users" - such as a child added to a parent's account - toward the credit histories of those authorized users.
Banks and other lenders use credit scores to determine the credit-worthiness of their customers and the likelihood the customer will pay debts on time. The lower your score, the higher the interest rates you'll pay for mortgages, car loans and other borrowing. If you have a poor credit history, lenders charge you more to make up for the increased risk of default.
This will be the fifth version of the FICO scoring system, which was introduced in 1989. The last change took place four years ago.
Fair Isaac revises the formula to make sure it keeps pace with consumers' credit habits, Watts said. It also regularly reviews credit-report data to get a better sense of risk patterns.
The latest refinement is expected to improve Fair Isaac's ability to predict defaults by between 5 percent and 15 percent. It provides a better sense of risk, especially for people in three categories: those new to credit, those with little credit history on file, and higher-risk, subprime borrowers.
Though Fair Isaac didn't plan it this way, the new system comes at a time when lenders are increasingly scrutinizing scores, experts said. With delinquencies and defaults soaring on mortgages and other loans, lenders have tightened their standards and made it harder for those with weak credit profiles to borrow money.
"Scores are perhaps more important than ever," said Ken McEldowney, executive director of Consumer Action, a consumer education and advocacy organization.
John Anderson knows the value of a good credit profile. In October, he qualified for a 0 percent interest rate on his new Saturn Ion because of his good financial background, which he has strengthened by paying off tens of thousands of dollars in credit card debt over the past eight years.
So the Bellmore resident is glad his quest for creditworthiness won't be derailed if he forgets to send in a payment on time. Just this month, he put a bill in a magazine he was reading and forgot about it. When he found it a week and a half later, the due date was two days away. He immediately paid the bill online, but he's not sure he made it in time.
"We can all miss a payment," said Anderson, 61, a retired supervisor for Suffolk's Department of Child Protective Services, who added that he doesn't actually know his credit score. He said he plans to check his score for the first time later this year.
Fair Isaac is being more forgiving because it has found that people with isolated delinquencies aren't really bad risks, Watts said.
New-account tolerance
Another reality of credit today is that people have more credit cards, he said. As a result, the new system is more tolerant of people opening new accounts or shopping around for credit. Under the new scoring, over the course of a year a person can open two to four new accounts without taking as much of a hit as previously. (The number of credit lines you can have before your score starts to fall depends on your overall credit profile.)
That's good news for consumers, said Richard Biondi, principal of RJB Financial Consultant, a Farmingdale-based mortgage brokerage. He outlined a scenario he often sees: A couple buys a new house and they need to furnish it. They go to Sears or Macy's, where they can get 10 percent off on this rather large purchase if they open a credit card account. They are then torn between getting the discount and hurting their credit score by adding another credit line.
"People don't want to open new accounts because they are afraid they'll get a ding on their credit," Biondi said. The new formula "will allow the borrower to put himself in control of his credit."
The last major change Fair Isaac is implementing involves authorized users. Under the old scoring system, a parent's timely payments on a card on which his child is an authorized user would help the child build a good credit history and score.
But under the new formula, Fair Isaac will no longer factor those payments into the child's creditworthiness. That's because of a practice known as "piggybacking," in which so-called credit repair companies pay someone with good credit to sign up a subprime borrower as an authorized user on their cards. The subprime borrower doesn't use the cards, but gets a boost in his credit score anyway.
Parents, however, have another option, said Greg McBride, senior financial analyst with Bankrate.com, a financial services Web site: They can open a joint credit card account with their child.
| Credit Score | APR* | Monthly payment |
| 750-850 | 5.19% | $1,646 |
| 700-759 | 5.41% | 1,687 |
| 660-699 | 5.69% | 1,741 |
| 620-659 | 6.50% | 1,898 |
| 580-619 | 9.26% | 2,472 |
| 500-579 | 10.22% | 2,682 |
The higher your credit score, the lower your interest rate and monthly mortgage payments are.
30-year fixed-rate mortgage of 300,000
*Annual percentage rate as of Friday
SOURCE: Myfico.com
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