Credit Scores: New Threats

A long-delayed update to the leading credit scoring formula is rolling out in 2009, offering a few advantages to consumers — and some serious new risks.

FICO 08, the latest version of the FICO scoring model, was initially supposed to be introduced in the fall but was delayed by lawsuits between its creator, Fair Isaac, and the nation's three main credit bureaus.

Fair Isaac says the new score will do a better job of predicting defaults than the classic FICO, which is used in more than 75% of mortgage lending decisions and by 90% of the largest U.S. lenders.

But FICO 08 is even more sensitive than the classic FICO to how much of your available credit you're using. If your credit card issuer slashes your credit limit — which is increasingly likely these days — you could see your scores plunge, regardless of whether you carry a balance.

Another hazard: The new scoring formula responds more negatively if consumers have few open, active accounts. Because more credit card issuers are shutting down unused and unprofitable accounts, that boosts the chances of damage to your scores.

Not all the news is bad. FICO 08 offers some definite improvements for consumers in several areas, including:

• Collections. The new formula ignores small collection accounts in which the original debt was less than $100. This is a big victory for consumers and one I've advocated for years, because niggling little debts — created by unpaid library fines, forgotten parking tickets or a small medical bill that slipped through the insurance cracks — had an outsize impact on people's scores.

• Credit missteps. Fair Isaac says the new version is less punishing to those who have had a serious credit setback, such as a charge-off or a repossession, as long as their other active credit accounts are all in good standing.

• Authorized users. Fair Isaac initially said FICO 08 would combat potential fraud by ignoring any "authorized-user" accounts in a borrower's credit report. After a big consumer outcry and potential credit fairness issues, Fair Isaac backed off and decided some authorized-user information would be included.

One of the biggest hazards for consumers is the credit utilization issue. As issuers slash credit limits, the gap narrows between customers' balances and their limits, which is generally bad for their credit scores.

Best advice: Pay down balances ASAP or you may see your score plummet.