Financial Education

Important changes to credit reports for 2008

Important changes to credit reports for 2008 By Tom Holcom, President of Pioneer Services, the military banking division of MidCountry Bank

Your credit report determines more than how much interest you could be paying on a credit card—it can affect how much you pay for car insurance, and even whether or not you are hired in some industries. These are just some of the reasons it is vital to keep tabs of your report and ensure it accurately reflects your credit history.

There are several changes coming in 2008 that will change how your credit score is determined, including some that offer you new ways to improve your score. There is also a new procedure you can utilize if you become a victim of identity theft, thus helping to protect your credit.

Changes to your score
How a credit score (called a "FICO" score after the company that first invented the formula, Fair Isaac Corporation) is determined is a closely held secret guarded by Fair Isaac and the three credit bureaus—Experian, Equifax and TransUnion. But financial experts agree that there are certain things that impact your score (listed in order of importance):

Payment history

Amount owed

Length of credit history

New credit

Types of credit

In the old model, each of these factors was weighted differently, with payment history being the most important (around 35 percent of the determination), and the types of new accounts and credit used both considered less important (around 10 percent or so).

There were also other actions that could raise or lower a score that most people never considered. For example, the old formula put an emphasis on "hard inquiries," which occur when a lender looked at your report when you applied for a line of credit. Even if you were not approved for the loan—or turned it down—that hard inquiry could lower your score.

FICO 08 is designed to put less emphasis on these hard inquiries, and will also change the impact of other items on your report. According to Liz Pulliam Weston, a finance writer for MSN Money, some of the other changes include:

More emphasis on:

Having a wider variety of credit accounts (positive)

Having high balances on your credit cards (negative)

Less emphasis on:

Actively using the credit accounts you have (positive)

Applying for new credit accounts (negative)

Fair Isaac has told reporters and finance experts that most consumers will actually see an increase in their score thanks to the new formula, but some may see a slight drop. The company also states that part of their goal is to more accurately judge who is and who is not a good credit risk, and to treat those with a troubled or short credit history more fairly.

They're also looking to minimize what is called "piggybacking" someone else's score. This is when someone with a good credit score adds someone with a poor score on a credit account (usually a credit card) as an "authorized user." Doing so imports the positive payment history of the account into the credit report of the person with a checkered credit history and, thus, raises that person's credit score.

This loophole came to light in 2007, when credit-repair companies started adding customer's information to the credit accounts of complete strangers with good scores. FICO 08 works around this by ignoring "authorized users" on an account and focusing on the actual account holders, including joint accounts.

The final big change in FICO 08 is that it takes into account modern economic reality: more people use credit more often than in the past. Because of this, actively seeking new lines of credit will not impact a score nearly as much as it used to (the "hard inquiry" issue noted earlier).

A change to your rights
Identity theft is one of the fastest growing crimes in America, with millions of people becoming victims in the past several years. It used to take an incredible amount of work to fix the problem, with the Identity Theft Resource Center (ITRC) stating that victims spend an average of 600 hours recovering from the crime and losing nearly $16,000 in potential or realized wages.

Fortunately, consumers in all 50 states can now "freeze" their credit report, something that used to be available in only a few states. Freezing prevents anyone from accessing the report, thus preventing criminals from opening new accounts since businesses won't be able to verify credit information.

The downside to freezing a report is that each bureau charges $10 for the service. Consumers will also need to pay a fee to release the report once the situation is resolved, or if the consumer wants to apply for a new credit account.

It's best to take a few steps before it gets this far, including keeping your Social Security number as secret as possible, getting your annual free copy of your report at www.annualcreditreport.com, and opting out of credit offers by calling 1-888-5OPT-OUT, or by visiting www.optoutprescreen.com.

To learn more about how to protect yourself from identity theft, read our article "Protect Yourself Against Identity Theft."

How to improve your score
Considering the new changes in how scores are compiled, there are several things you can do to increase your score:

Review your report—Since just one negative item can affect your score, make sure your report is accurate. As noted earlier, you can get a free copy once a year from all three bureaus at www.annualcreditreport.com. Note that this is the only site legally able to give you free copies; there are other sites that claim to be able to do so, but they have been noted for fraud and charging you a fee. Once you get your copy, dispute any accounts that aren't yours, as well as negative items more than seven years old (10 years if you have filed bankruptcy). You may also want to visit a Certified Credit Report Reviewer, since these professionals have detailed knowledge on how to read a report and other ways you can increase your score.

Pay on time—The new scoring method also puts more emphasis on missed or late payments, so even missing a single payment on a single account can lower your score. To prevent this, consider paying bills by allotment, or set up online bill paying through your bank or credit union to have payments sent automatically each month.

Keep balances low—FICO 08 penalizes you for using too much of your available credit, so try to keep it at around 30 percent of the credit limit. For example, if you have a credit card with a $1,000 limit, it's better to keep the balance at $300 than $800. If you find yourself using the card often, but not maxing it out, then call and get the credit limit raised; doing so will lower the percentage of available credit you are using and increase your score.

Keep accounts open and active—In the past, closing unused accounts would lower your score by a small amount. And since some creditors would automatically close accounts that had not been used in some time, some consumers would have their score reduced through no real fault of their own.

Piggyback the right way—The new FICO formula, like the old one, does allow you to benefit from someone else's positive credit history. The difference with FICO 08 is that you cannot simply be an "authorized user" of the account to benefit; instead, you must be a "joint account holder." The good thing is that doing so can increase your score almost immediately, as long as the account remains in good standing. The bad things are that you are now jointly responsible for the debt, and you also may have difficulty being removed from the account (an authorized user can be removed with a phone call, whereas a joint account holder will have to fill out a stack of paperwork). So if you do piggyback, make sure the account is in good standing and is one you want to stay on for an extended period of time.

Consider an installment loan—With the old FICO model, you could simply have several credit cards and receive a high credit score. With FICO 08, you get a higher score by having several different types of credit accounts. Because of this, Pulliam Weston of MSN Money suggests that if you're having issues paying down your credit card debt, an installment loan is "recommended as a way for people with troubled credit to rehabilitate their scores" since it adds variety to your credit choices.

While it will be the summer of 2008 before the credit bureaus fully implement the new scoring model, making changes now to the ways you use and pay for credit will set you up nicely for when the change occurs. And since any of the steps outlined above will actually help your score now, there's no better time than the present to prepare for a secure financial future.

About the author
Thomas H. Holcom, Jr., is the president of Pioneer Services, the military banking division of MidCountry Bank, which provides responsible financial services and education exclusively to the military community. Holcom has more than four decades of experience in banking and finance, and serves on numerous philanthropic boards, including Business Executives for National Security and as president of the Command General Staff College Foundation.

For more information visit www.pioneerservices.com. For loan information, visit pioneermilitarylending.com.

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