Q: I heard that the company that calculates credit ratings for consumers is changing the way that it puts together its credit scores. Is this true? If so, what are the changes? I am interested because I am planning to shop for a new mortgage after my son graduates from school in June.
Yes, Fair Isaac Corp. - the company that compiles the FICO scores reported by credit bureaus and then used by lenders to determine a potential borrower's creditworthiness - recently revamped its scoring system.
The changes could result in an increase or decrease of 20 points or more to your score, which in turn could help you easily save more than $500 or $1,000 a year in interest charges if your score improves, but could cost you dearly if the new model pushes your rating lower.
Q: Why is my FICO score important?
It's important because an estimated nine-out-of-10 lenders check it when determining whether you should be approved for credit, regardless of whether you're seeking a new mortgage, a car or personal loan, or a credit card. Scores start at 300 and go up to 850: The median score hovers around 720, meaning that half of Americans have a score greater than that and the other half score lower.
The higher the rating, the better. If you have a rating of 760 to 850, you have proven that you have done a sterling job of handling your debt responsibly through the years and will probably continue to do so in the future. As a result, you'll have a good chance of getting a loan at the lowest rate possible because you're less likely to default than someone who has a lower score.
Q: How is Fair Isaac changing its scoring system?
One of the most important changes involves a one-time late payment on an account. In the past, just a single bill that went 90 days past its due date could put a serious dent in your FICO score.
Under the new rules, failing to make the payment may be reconsidered an "isolated delinquency" if you are in good standing on other accounts and have a credit history of 10 years or more.
Q: I have made my monthly mortgage payments on time for several years, but it bugs me that my FICO score doesn't seem to give me credit for that. What can I do?
It seems unfair, but many mortgage lenders don't report a responsible borrower's on-time payments yet are quick to alert the nation's three big credit bureaus - Experian, TransUnion and Equifax - if an owner falls behind.
The recent moves by FICO will change that. The company's revamped rules will raise the credit scores of borrowers who have a good mixture of revolving debt, like credit cards, and also have a solid repayment history on their mortgage loans.
Q: Who will benefit most from FICO's changes?
The biggest impact will be felt by borrowers who are straddling the line that lenders individually establish to separate one group of borrowers from another.
Let's say that you started the year with a credit score of 695, which many lenders consider to be near the top-end of the "good" or "very good" score bracket.
If the changes boost your rating by a relatively modest 10 points, your new 705 score may catapult you into the "excellent" class and could qualify you for about a one-quarter point reduction in the interest rate on your next mortgage. On a $300,000 fixed-rate loan, FICO says, the lower interest rate would save you about $55 per month.
Conversely, if you began the year with a score of 660 - which many banks consider to be the lower end of the "good" rating level - and the changes result in a 10-point drop in your score, you might then fall into a lower rating category and could be required to pay about three-quarters of a point more to get a loan. On that same $300,000 mortgage, the higher rate could cost you an extra $160 per month ($1,920 a year) or more in interest payments.