Who’s The Big Winner From New Credit Score Rules?

The most widely used credit scoring model in the U.S. is changing, and there will be one clear winner.

Aug 17, 2014 at 1:00PM
Credit

Flickr / Lending Memo.

When it comes to credit scores, the FICO scoring model by Fair Isaac Corp is the most widely used by lenders to determine the creditworthiness of prospective borrowers.

It was recently announced that some changes are taking place in the FICO model which are likely to boost the credit scores of millions of U.S. consumers. Are these changes for the better, or will they artificially inflate credit scores, giving loan access to consumers who shouldn't have it? And who stands to benefit most from the changes?

What's changing?
Basically, the FICO score will no longer include paid collection accounts, and will weigh unpaid medical collections much less heavily than it previously did.

So, if you have an old collection holding down your credit, as long as it's been paid, your score is very likely to rise once the new formula kicks in this fall.

And according to the Wall Street Journal, there are plenty of people in this situation. Out of the 106.5 million American consumers with some type of collection account on their report, 9.4 million had a zero balance.

The biggest impact should be seen in consumers where a paid collection or an outstanding medical debt is their only credit issue. If someone has a few late payments on current accounts in their credit report, for example, the removal of paid collections from the report will probably have less of an impact.

Aren't we asking for trouble?
One of the biggest causes of the financial crisis was credit being given to people who didn't deserve it. So, by ignoring some past credit behavior, aren't we artificially increasing the appearance of creditworthiness for some borrowers?

Well, yes, but not to the extent that it seems.

People who are really bad with credit generally don't just have a single issue (like a paid collection or medical debt) holding their score down. One paid collection item in an otherwise solid credit history usually doesn't drop a score into the "poor" credit level.

What this will do is make credit more affordable to a lot of people. According to one former FICO employee, the changes are not likely to be so drastic as to make the difference between approval or denial of a loan, but they may qualify borrowers for lower interest rates. This means that big-ticket purchases like homes and cars will become more affordable for a lot of people who until now have been forced to pay above-market interest rates.

The big winner
Banks are going to be the real winners here. Consumer lending activity is already performing very well, and giving more people access to credit at lower interest rates will provide yet another boost. Mortgage lending has been the one weak spot, as rates have risen and home values are about 27% higher than their 2012 lows. And, because of the long timeframes associated with mortgage loans, a small improvement in a mortgage rate can make a big difference.

House

Flickr / Mark Moz.

For example, according to myfico.com (where you can buy your FICO score), the average 30-year mortgage rate for someone with a 650 FICO score is currently 4.832%. If the new rules were to boost that score by just 20 points, the average rate drops to 4.402%. This may not sound like a lot, but on a 30-year, $250,000 mortgage, it makes a difference of more than $23,000 in interest over the life of the loan.

So, banks are likely to see more mortgage originations as reluctant homebuyers who suddenly qualify for lower interest rates come off the sidelines. And, as long as the banks lend responsibly by verifying buyers' ability to repay and requiring substantial down payments, a big increase in the default rate is unlikely.

Your credit card may soon be completely worthless
The plastic in your wallet is about to go the way of the typewriter, the VCR, and the 8-track tape player. When it does, a handful of investors could stand to get very rich. You can join them -- but you must act now. An eye-opening new presentation reveals the full story on why your credit card is about to be worthless -- and highlights one little-known company sitting at the epicenter of an earth-shaking movement that could hand early investors the kind of profits we haven't seen since the dot-com days. Click here to watch this stunning video.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers