You might not have heard the news yet, but the Fair Isaac Corporation, the creator of the FICO credit score, is introducing a new model to consumers. If you don't use debt instruments, or, have not had a credit card, student loans, lines of retail credit, an auto loan, or even a mortgage, you are likely not to have a credit score. There are approximately 53 million Americans that don't have a credit score, either because these individuals never applied and used credit lines or because of a big financial event, like a bankruptcy.
Even if you have a good credit score and cut-up all your plastic, pay off all your debt, and stop using lines of credit, in about half of a year, to eight months, up to a year, your credit score will effectively disappear. This is also a reality for women who marry and use their husband's credit, as well as those who have lived overseas for a few years. To maintain a credit score, you have to use lines of credit on a regular basis, if you are the cash-only type, you're highly likely to have no score at all. Because there's no way to measure your risk level to lenders, and to credit issuers, you're left without a score.
That's the problem, the catch-22 which young adults often face. We all know that scenario, you have to have credit in order to apply for credit. Though this conundrum is troubling at first, eventually, it's not a problem to build a good credit profile and hold onto to it for years. However, it's those tens of millions of consumers who don't use debt instruments that have the most problem with obtaining a mortgage, and, nearly regardless of their cash position.
Traditional FICO Score Modeling
About 200 million consumers do have a credit score, and the average score is 687, on a scale from the low 300's up to the mid 800's. In August of last year, the Fair Isaac Corporation announced it would include a bit of nuance in it's modeling, lessening the impact of medical bills. Because these are so common and typically inflated to a great measure, FICO now puts less emphasis on medical debt. However, this doesn't help consumers who use their debit cards, pay their bills on time, and don't use credit lines.
"In the finance world there is what’s known as the Catch-22 of credit. Only those consumers who already have loans and make payments that show up on their credit report can get a credit score to help prove their trustworthiness to financial companies. Those who work mostly in cash but want greater access to credit are often locked out of the lending market because financial institutions don’t have enough information to evaluate them." --Washington Post
For those who do use credit, your score is built and calculated through five factors. Your payment history is the largest, accounting for 35 percent of your score. Right behind it is the amounts you owe, which makes-up 30 percent of your score. Your payment history accounts for 15 percent of your credit score, while types of credit and new credit lines account for 10 percent each. Your salary, age, and place of residence have no impact on your score.
New FICO Score Model Developing
If you don't have a credit score because you've spent a few years out of the country or just pay cash and/or use a debit card, you'll probably find that you don't have a credit score and if you apply for a mortgage, that will generally present a problem. You can seek out a lender that offers manual underwriting, which means actually doing a little bit of financial background checking and together with your down payment, qualify you for a home loan.
FICO just announced that it too, will be introducing a new credit score model, which does much of the same thing. Instead of relying on lines of credit, payment history, and debt-to-income ratios, it will score consumers based on other factors. The reason for this sea-change is in response to lender requests. The financial downturn of 2008 and 2009 left many banks with hundreds of millions in unpaid loans. Car loans, private student loans, mortgages, home equity loans, small business loans, and more defaulted in record numbers.
Now, Fair Isaac is responding by basing a new credit scoring system that includes utilities and number of years of residence. In other words, your payment history for your electric bill, water and sewer, cable, land line phone, cell phone, and other utilities will all be counted. This will be done by pulling data from telecommunications companies that's maintained by credit bureau Equifax. It will also include information taken from the LexisNexis database, as well as how often you do or don't move. This is welcome news for lenders and consumers alike who are responsible with their finances.