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Changes Coming to Credit Score Calculations

Consumers with debt have something to look forward to in the Fall of 2017: a new version of VantageScore. This credit scoring model was introduced in 2006 by the three major credit reporting companies. The new credit score system, VantageScore 4.0, is supposed to provide more insight into a consumer’s use of debt and the risk a lender may be taking on by extending credit.

How is the new model different?

VantageScore 4.0 will put more weight on the trends in a person’s credit report rather than looking at a point in time.

For a look at how this works, consider the following scenario:

Julie has one credit card with a $5,000 limit and a current balance of $2,500. Last year, Julie maxed this card out when she was laid off, but since that time, she hasn’t used the card and has been diligently paying down the balance.
Jeff has two credit cards, one with a $2,000 limit, the other with an $8,000 limit. Jeff uses both cards regularly. He pays his bills on time, but his utilization rate typically remains around 50 percent of the balance for each card.
Jessica has two credit cards, each with a $2,000 limit. She just maxed out one card to book an expensive vacation and take advantage of her card’s rewards program, but she typically does not carry a balance, paying the card off before incurring any interest charges.

Each person in this example has a 50 percent credit utilization ratio. Under standard credit scoring rules, all three are penalized for using more than 30 percent of their available credit limit. Under the new model, Julie and Jessica’s handling of credit is looked on more favorably than Jeff’s. Julie is favorable because she’s making progress toward paying off her debt. Jessica typically pays off her balance in full each month, which is a positive trait.

Who uses VantageScore?

Currently, VantageScores are used by more than 2,400 lenders, including 20 of the nation’s 25 largest financial institutions. A good VantageScore can help consumers qualify for many types of credit, but perhaps not a mortgage. The FICO system is currently the only credit scoring tool approved for use by government-sponsored enterprises such as Fannie Mae and Freddie Mac, though that could change in time.

Why does your credit score matter?

Your credit score plays a crucial role in your financial life. It largely determines whether you’ll be approved for a loan or credit card and how much you’ll pay in interest. Your score determines if you can get approved to rent an apartment and the size of your security deposit. It also effects how much you’ll pay for insurance, and even your cell phone plan.

Clearly, your credit score has far-reaching implications in many aspects of your life. So, if you’ve made a few missteps with your credit in the past, what can you do to improve your score?

Under the old system, you might be able to pay down debt and quickly to improve your score before applying for a new loan. Because VantageScore relies more on your historical use of credit, however, that type of “quick fix” may not be as effective.

Instead, consistently practice these good credit habits over time:

  1. Keep credit card balances low. Aim to keep your credit utilization ratio at 30 percent or lower. That’s 30 percent of any one card as well as 30 percent of your available credit as a whole. However, one large purchase that kicks you over that threshold should not have a large impact under the new model, as long as you have a history of low utilization.
  2. Pay your bills on time. One of the biggest factors in a good credit score is simply making on-time payments month after month. Set up reminders on your calendar or automate payments to make sure that you never miss a due date.
  3. Order a free copy of your credit report annually and review it for errors. If you notice any errors that could be negatively affecting your score, take the necessary steps to remove inaccuracies.

Author

Janet Berry-Johnson

Janet Berry-Johnson is a CPA and a freelance writer with a background in accounting and insurance. Her writing has appeared in Forbes, Guyvorce, Magnify Money, Freshbooks, Intuit's Firm of the Future, Discover Student Loans, and Chase News & Stories. Janet lives in Arizona with her husband and son and their rescue dog, Dexter.

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