Credit Crunch | How will you be affected by the new Credit score Calculations?

Credit Crunch | How will you be affected by the new Credit score Calculations?

February 27, 2020
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In January it was announced that a new FICO Score will be available this summer. The new scoring will change the way that scores are calculated and could have a big impact on consumers and their individual scores. The new system more heavily weighs credit card debt and lines of credit. It will also factor in a longer time period, 2 years. If you had missed payments or had higher levels of debt in the past, it could negatively affect your score under the new FICO 10 calculations. For those with a good payment history and low levels of debt, the new model should help you to improve your score. Since the new scoring model will not go into effect until the summer, consumers will have time to adjust their borrowing habits to help avoid a drop in score.

Knowing your credit score has become almost as important as knowing your phone number or home address.  Whether you wind up with a higher or lower score under the new system, it is important to know what a credit score is, why is it so important, and what can be done to raise your score and keep it at a higher level.

What is your Credit Score and how is it Determined?

 “A credit score is a statistical number that evaluates a consumer's creditworthiness and is based on credit history.[1]” Your credit history is detailed in your credit report. The items that are listed on your credit report will be used to determine your credit score and can include[2]:

  • Personal information such as any name you have used in the past or present for a credit account, current and former addresses and phone numbers, birth date, and Social Security number.
  • Credit Accounts both current and past including the type of account, the limit or amount, the current balance, payment history, date account was opened/closed, and the name of the creditor.
  • Collection items that can be found in public records including liens, foreclosures, bankruptcies, civil suits or judgements, and overdue child support.
  • Inquiries made by companies that have accessed your credit.

Who will use your Credit Score?

Your credit score can be used by various institutions and could be used in ways that greatly impact your life[3]:

  • Banks and Financial Institutions
  • Credit Card Companies
  • Automobile Dealers
  • Insurance Companies
  • Department Stores
  • Utilities, Cable, and Cellular Providers
  • Landlords
  • Employers

How is your Credit Score Used?

Different entities will take a look at your credit for various reasons. Ultimately, they are trying to determine what kind of person you are. Are you trustworthy? Do you honor your commitments and responsibilities by repaying your debt? Are you overextended? Have you taken on too much debt?

After pulling your credit a lender could give you a higher or lower interest rate depending on your score. Insurance companies can use your score as a factor in determining what premiums you will pay. Utilities may require a deposit if you have a poor credit score. Landlords could use your credit score to help them make a decision to either accept or deny your application. Employers may decide to go with another candidate if you have any red flags on your credit report.

What can you do to improve your credit score?

There are many steps that you can take to improve your credit score and your financial position in the short term and for many years to come.

  • Pay down debt
  • Pay your utility and cellphone bills on time
  • Keep unused credit accounts open instead of closing them
  • Only open new credit when you have a need to

It all comes down to understanding how a credit score is calculated so you can make financial decisions that will increase your score rather than bring it down. For instance, recognizing that length of credit is a consideration and therefore deciding to keep an old account open which will have a positive impact on your score. You might also reconsider opening new lines of credit frequently such as applying for multiple store credit cards knowing that this could negatively impact your future goals by decreasing your credit score.

You are more than your Credit Score

It can feel a bit unfair at times. There will be a lot of people who will make judgments about you based on one small aspect of your life. Your credit score and credit report can tell a lot about you, but they will never tell the full story. That is up to you. There are many reasons that people get into debt or fall behind on their debt payments. Some of them are valid while others are not. When applying for a loan, job, or new apartment, do what you can to put your best foot forward even if your credit score is not as high as you would like it to be yet. A landlord might reconsider if you explain the reasons for some of the negatives on your credit report. Prove to a potential boss that you are the right person for the job by having a good attitude, demonstrating a high level of skill, and explaining how your credit was negatively impacted by your past and the ways you are working to improve it in the future.

The good news is, there is a lot that you can do to improve your credit score if you do fall behind for any reason. A commitment to sound financial practices such as living within your wage, paying your bills on time, paying old debts as quickly as possible and avoiding new debts when you can will help you to get on the right track. Once you achieve the credit score that you desire, work to keep your credit strong. Build up your emergency fund to avoid the need to take on new debt. Consult a financial professional to help you create a financial plan that will help you to achieve your current and future goals. Make the decision to help your future self by starting good credit practices today.

[1]https://www.investopedia.com/terms/c/credit_score.asp

[2]  https://www.consumerfinance.gov/ask-cfpb/what-is-a-credit-report-en-309/

[3]https://www.debt.org/credit/report/

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Any named entity, Pinnacle Wealth Management are not affiliated.

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