Your credit score can determine whether you can buy a car, get certain jobs or rent an apartment. It's a big deal. And so is this: Credit scores for many Americans are about to change — even if they don't do anything.
The changes will be extensive. About 40 million Americans are likely to see their credit scores drop by 20 points or more, and an equal number should go up by as much, according to Joanne Gaskin, vice president of scores and analytics at FICO, the company at the heart of the credit scoring system.
Every five years or so, FICO updates the way it determines credit scores. This time, the biggest change is in how it treats personal loans, Gaskin says.
Personal loans are growing faster than any other consumer debt category; Americans owe more than $300 billion on them. There are all kinds of personal loan offers in the mail, online and on TV. Many promise to lower your interest rate by consolidating credit card debt into a single loan.
For the first time, Gaskin says, FICO is breaking out personal loans as a distinct category to determine whether borrowers use them responsibly.
Why does that matter?
Let's let's say you pay off all your credit cards with a personal loan. Under the old system, your credit score might go up. But under the new approach, FICO will look back over a period of time — as far as two years — to see whether you've used the loan to reduce your high-interest credit card debt or whether you're using plastic as much as before, running up new revolving balances and falling deeper into debt.
"What we find is that potentially that consumer's credit file carries more risk than what was apparent," Gaskin says.
If your finances are in good shape and you already have a good credit score, you're likely to see your score improve, she says. But Gaskin says those whose scores will decline are typically people in the lower FICO score range, about 580 and below. (FICO scores range from 300 to 850.)
That's not good news for people who are struggling financially, says Marisabel Torres with the Center for Responsible Lending. "It sounds like we're penalizing people for getting into a bad situation."
Torres says people who already have low scores are most likely to see their scores go even lower — and that will worsen inequities in the credit system. With personal loans, people with good credit can qualify for good terms. But Torres says predatory lenders charge people with lower incomes very high interest rates.
"A lot of the predatory products concentrate these offers in lower-income neighborhoods, targeting communities of color especially who tend to have the more limited options for financing and for credit," Torres says. "They end up getting ensnared and into this cyclical debt."
She says it doesn't seem fair that now, on top of that, many will be getting hit with a lower credit score than they would have before.
With some loans, especially home mortgages, lenders tend to use older versions of the FICO score, so the new version won't have an impact on all types of lending.
Gaskin says the goal with FICO's newest score is to give lenders better information so they can extend credit to more borrowers at better rates.
While you can't control the way the scoring system works, there are steps you can take to improve your creditworthiness. "Don't make late payments on a regular basis," says Sara Rathner of the personal finance site NerdWallet. "Pay all of your debt obligations on time every month. That's huge."
Rathner says one thing a lot of people don't realize is that it's often unwise to close older credit card accounts. "So many people think about 'cleaning up their credit' as as like Marie Kondo-ing their wallet," she says.
But Rathner notes that when it comes to credit cards, it can help to hold on to older accounts for a long time. Doing that gives consumers a more established credit history.
If an older card is charging you an annual fee, Rathner says, you can often get the issuer to switch to a card with no fee, while still keeping the extended credit history intact.
She offers another tip: Don't use more than a third of your available credit on all your credit cards. If you exceed that threshold, it can hurt your credit score.
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