Like everything else in life, the way lenders look at your credit is undergoing a big change.
New credit scoring models challenge traditional FICO stranglehold on industry
According to a recent CreditCards.com survey, 36% of young people between the ages of 18 and 29 have never had a credit card. So that effectively leaves more and more millennials with what’s called a ‘thin file/no file’ in the eyes of the credit bureaus. Simply put, that means there’s not enough info in their file for lenders to make a lending decision. So lenders who want to do business with these millennials are having to flex and find other metrics on which to gauge their creditworthiness.
SoFi, the hot student loan refinancer, is leading the charge into new territory. ‘We’re taking a more holistic view of our applicants’ financial well-being — and where they’re headed,’ the company writes on its site.
Instead of pulling your FICO score, SoFi is instead looking at your savings, cash flow, ability to pay non-credit bills and your future earnings. So they’re putting a premium on you paying every bill you have on time each and every month; your monthly income vs. expenses; and the likely trajectory of your career based on education and experience.
Interestingly, what’s old is new again. Paying every bill you have on time each and every month is something Clark and almost every other personal finance mentor has talked about for years. In fact, it’s the number one factor that influences your traditional FICO credit score too.
Read more: Free access to your credit report and score
Before we go any further, it’s useful to take a look at traditional credit scoring and get a closer look at what exactly makes up your score…
What’s in your score?
FICO uses five factors to determine your credit score. Here they are from most important to least important…
- Always pay your bills on time and pay down the total amount you owe.
(accounts for 35% of your score)
If you forget all else after reading this, remember this one! This is the single most important rule for having a good credit score.
- Keep a low credit utilization rate.
(accounts for 30% of your score)
Let’s say you have a credit card with a $10,000 limit. If you’re carrying a balance month-to-month of $3,000, you’re only using 30% of the total limit. But if your credit limit is suddenly dropped to $3,000, then suddenly you’re using 100% of what’s available to you. That’s yet another reason to always pay down credit card debt as quickly as possible. You always want to stay at credit utilization of 30% or less.
- When you pay off a credit card, don’t close the account.
(accounts for 15% of your score)
You want to have between four to six lines of credit. Be sure to use them twice a year — even if it’s just for a dollar store purchase — and pay them off right away. That will keep them active in your credit mix. If you’re facing a huge new annual fee on a card that has a zero balance, try ‘leapfrogging.’ That’s Clark’s term for using the 45-day window you have before any new terms of service go into effect to shop around. So once you get notice about a new annual fee, start looking around for other no-fee credit cards. Submit your application and once you get your new no-fee card, then go ahead and shut down the original one that wanted to spring a fee on you.
Timely rent payments are among the factors being looked at in other new scoring models
Not one to be outdone by the likes of SoFi, the three main credit bureaus are expanding their vision of the credit score too.
Case in point: Renters who pay their rent on time each and every month are seeing their traditional credit scores getting a nice boost.
Previously, rent would only really show up on your credit report if you were late or got evicted. But you couldn’t get any brownie points for paying on time each and every month.
That all changed back in 2014 when Experian and TransUnion began incorporating rental payments into credit files, and then in turn, into your credit score. Equifax has since gotten on board to with a similar initiative just in the last few months.
The good news is syndicated writer Kenneth Harney reports that renters who have their on-time payments reported are seeing a significant increase in their credit scores after just one month! So this is another way you can build your credit slowly over time.
Will the FICO score every go away or lose ground completely to a new way of credit scoring? It’s impossible to say, but it’s pretty unlikely. In the meantime, it’s just nice to know there are more options out there to build your credit — one bill at a time, one month at a time — if you’re one of the ‘thin file/no file’ people!