A new formula that calculates the consumer credit scores used by lenders in determining viable borrowers is in the works. Typically, credit scores range from 500 to 850 points and are calculated by a firm called Fair Isaac. These credit scores are referred to as FICO scores. FICO scores are used by potential lenders to determine if they will extend credit and at what rate. The higher your FICO score, the better interest rate you’ll receive on loans, which translates to substantial savings.

Currently, five factors, weighted as shown below, determine FICO scores:

• timely payment, 35%


• ratio of debt-to-credit limit, 30%


• the length of credit history, 15%


• the number of credit applications, 10%


• the variety of loans, 10%

In 2006, Fair Isaac began to look at ways to tweak the current way FICO scores are calculated, for two reasons. They wanted to give creditors a more accurate prediction of which borrowers were more likely to default by including factors in the formula that differentiated a good-risk borrower from a bad-risk one. And they also wanted to address the 20% of the consumer population that’s denied credit because they have either no credit history or a thin credit history. This 20% includes recent immigrants, young adults, recent college graduates, and consumers who don’t have checking or savings accounts.

Here are some of the changes that may ultimately boost credit scores:

1. Timely payment: Payments that are past due by 90 days or more continue to negatively affect your current FICO score. Under the new calculation, a person with a credit history of 10 years or more and in good standing will no longer suffer a low FICO score because of this overdue payment of several years ago. The new system will regard the oversight as an isolated incident instead of constantly penalizing you for it. As a result, credit scores could jump as high as 25 points, according to Craig Watts, spokesperson for Fair Isaac.


2. Number of credit applications: The current calculation penalizes borrowers for loan shopping. Every credit history inquiry heavily weighs down a FICO score. The new calculation understands that the average person today carries more credit cards and obtains more loans than in the past. As a result, inquiries into credit history will weigh less on the score.


3. Ratio of debt-to-credit limit: The new calculation will penalize credit card holders for carrying near maximum balances on their accounts. This activity will be interpreted as a sign of bad debt management. Even if you make timely payments, your credit score could plummet 20 points just by having credit balances close to the limit. However, since the new calculation won’t penalize you for multiple credit inquiries (see number 2), you can apply for and carry a few more credit cards to increase your available credit while spreading around your debt. This will give you a lower debt-to-credit ratio and a higher FICO score, as opposed to carrying one card close to the credit maximum, which would cost you precious points.


4. Length of credit history: The old calculation allowed borrowers with lower scores to piggyback with higher-scoring borrowers. This situation is typical of parents helping their child learn to manage credit by making the child an authorized user on their credit card. The credit history on that credit card becomes part of the child’s credit history, too, immediately giving the child a higher FICO score than would have otherwise been possible.
   
   Because of the immediate affect on FICO scores, “piggybacking” has sprung into an industry. Here’s how it works. Credit card holders with high FICO scores agree to allow low FICO score debtors to piggyback on their credit record history. Piggybackers become authorized users on a credit card account, absorb the credit history of that account, but can’t use the credit card. The debt organization pays the cardholders a one-time fee of around $200 for each piggybacker they allow as an authorized user on the account. The piggybacker pays the debt organization several thousand dollars to become an authorized user on that account. The new calculation will eliminate this piggybacking (even for parents trying to help their kids), forcing everyone to establish their own credit history. The debt organizations that offer this service are opposed to this change to the calculation.


5. Variety of loans: The new calculation will look favorably upon borrowers who carry and successfully manage a variety of loans. If, for example, your records indicate a solid credit history of managing installment loans, such as a car payment or a mortgage, and a few revolving credit cards with low balances, and you make your payments on time, your FICO score could increase. Carrying only maxed-out credit cards will lower your score.

To compensate for 20% of the consumers who have thin to no credit histories, the new FICO calculation has been expanded to include other factors to fill in this information gap. Creditworthiness can be determined by analyzing consumers’ tendencies and influences. A tendencies analysis would reveal your spending and payment habits as well as your personality characteristics that fuel your spending behavior. An influences analysis would reveal your spending preferences and what motivates you to spend. To include these nuances, new factors added to the calculation include:

• Public information such as criminal records, tax liens, and bankruptcy filings (tendencies)


• Payment record of monthly rent and leases, utilities, cable, and insurance bills (tendencies)


• Catalog and Internet purchases (influences)

Fair Isaac had expected lenders to begin using the new calculation in the fall of 2007. However, in a joint venture, the three credit bureaus developed their own calculation, called VantangeScore, to compete directly with the FICO calculation. As a result, Fair Isaac filed a federal antitrust lawsuit against the bureaus—Equifax, Experian, and TransUnion—accusing them of unfair anticompetitive practices implemented to harm the FICO brand.

In June 2008, Fair Isaac dropped its lawsuit against Equifax. According to Lisa Nelson, vice president of Fair Isaac, Equifax stopped using the unfair practices cited in the federal antitrust lawsuit. Using Equifax's consumer credit information and Fair Isaac's scoring capabilities, Fair Isaac and Equifax will jointly market and sell the new FICO analytic products to lending institutions. Nelson also said that Fair Isaac plans to pursue the federal antitrust lawsuit against Experian and TransUnion credit agencies.