Guest Column by Pat Earnhardt
Mortgage Consultant and Senior Mortgage Banker,
The Mortgage Rewards Team of Alera Financial

How Your Score Is Determined Will Change In September - Will Yours Go Up Or Down?

About 60 million consumers will be affected by plans to roll out a new credit scoring formula in September by Fair Isaac Corp., the developer of the widely used and accepted FICO score. At least one of the major credit reporting agencies (Equifax, TransUnion & Experian) is expected to adopt the new scoring model in early fall and the other two by the middle of 2008. Out of the 50 top financial institutions in the country, 40 rely on your FICO score to decide if your loan should be approved and often to determine your interest rate.

In the past, FICO has had a few minor tweaks to its scoring formula; however, this adjustment is probably the most significant since the 1980’s. Here are the two biggest changes in determining your FICO credit score:

An end to credit boosts for authorized users on accounts - Fair Isaac estimates that about 30% of the 165 million consumers with enough information on their credit reports to have a credit score calculated have someone on their account as an authorized user. Authorized users on credit cards are not responsible for paying the balances but are approved to make purchases with the cards. Often, authorized users are family members of the actual cardholder, such as a college student on his/her parents' card or spouses who may have little or no credit of their own. With the old scoring model, coat tailing by authorized users could improve their credit score considerably if the primary cardholder kept balances low and paid the required monthly payments on time over a long period. In the past, using the authorized signer benefit has been used to help establish and/or boost credit scores for family members.

If you have a loophole with such great benefits as this one has had, someone out there will find a way to exploit it to make money. A major reason this aspect of scoring is changing is because lenders and industry officials have raised concerns over “piggy backing”. Piggy backing is a form of credit renting, a growing practice that allows people with bad credit to piggyback on the strong payment histories of credit card holders by becoming an authorized user on the account. A person with no credit score or a low credit score pays a fee to rent a spot as an authorized user on a stranger's account. The payment given to the person allowing the piggybacking on his or her credit history depends on the quality of his or her credit line. With their newly improved score, consumers are able to obtain a lower interest rate on mortgages, car loans or personal loans and in some cases it helps them get their loan approved instead of denied. Many observers believe that piggy backing could well be a contributing part of the problems being experienced by some consumers in connection to their Sub-Prime or near Sub-Prime loans.

Tom Quinn, Fair Isaac's Vice President of scoring solutions, said it was a challenge to find a solution addressing this credit borrowing problem because there was no way to distinguish between family members and strangers due to privacy laws and the Fair Credit Reporting Act.

John Ulzheimer, President of educational services for Credit.com said in an article in USA TODAY that once this new scoring model is adopted, millions of authorized users will see their credit scores decline and authorized users with no credit history of their own will see their credit score disappear.

Adding more population gegments - Another major change is the addition of two more population segments. The theory at play with this segment change is that more population segments will make the scoring system more accurate overall, since the risk of putting someone in the wrong pool will be lower. In the past, FICO grouped consumers into 10 groups or consumer pools called population segments. These groups fell in pools -- such as high-risk borrowers or borrowers with thin credit profiles, etc. Each group uses a slightly different version of the credit scoring formula.

Under the new system, the population will be divided into 12 segments: eight for people with good credit and four for people with bad credit. This increase in groups could result in a slight change of a consumer’s credit score either up or down. But even a slight movement of your score could have an impact on your interest rate or ability to be approved for a loan. If your score moves up just a little it may save you thousands of dollars on a long-term loan. If it moves down, it could cost you thousands of dollars on a long-term loan. Even if your credit score remains unchanged that doesn’t mean you won’t be affected if you are married. Each other’s credit scores often will affect spouses. For instance - When getting a mortgage, it is usually required to obtain a combined credit report called a Tri-Merge Report with information and credit scores from all three credit-reporting agencies. If both the husband and wife are listed as co-borrowers for the loan, the score of the spouse with the lowest middle credit score is the one typically used.

So - What can you do now if you fall into one of the groups that will be afftected by the new scoring model? It may take a little longer and require greater attention on your part, but there are things you can do to protect or help your credit score under the new system.

• If you are married and you are currently listed as an authorized user on your spouse’s credit account, convert the account to a Joint Account. This is particularly important for women, because history shows that women are more likely to be listed as an authorized user than men are. Joint account holders are given the same status on credit reports and in credit scoring.
  
• A great tip for younger consumers (but available to nearly all of us). Apply for a secured credit card in your own name. These types of accounts are much easier to get than other credit accounts because you will have to deposit upfront money with the lender. Your available credit line is usually the amount of your deposit. If you check around you should be able to find one with no application fee and no annual charge. On occasion you can find one that will actually convert to a regular credit card account if the cardholder makes the agreed upon monthly payments in a timely manner over a set period of time. A good place to start looking for a secured card is at a Credit Union.
  
  A secured card can be an excellent way to enter the world of credit. One note to make is that some of these accounts do not report to all three credit reporting agencies. The only way to know for sure is to ask. Only take the card if the credit history is reported - keep in mind that your goal is to build a credit profile. If they don’t report your history on this account - this doesn’t help you at all in establishing and/or building your credit.
  
• Apply for a store card in your own name. Store cards are usually easier to obtain than major credit cards, but they also typically have lower credit line limits, higher interest rates, and often higher required monthly payments. Use them wisely, stay within your limits, and always pay them on time.