An outdated credit system
Fair, Isaac, and Company (FICO) launched the first versions of the credit report in 1981 to determine an individual’s financial stability and likelihood of prompt debt repayment. Over the next few decades, major credit bureaus began to keep their own databases for FICO scores. These days, you likely have a different score with each of the bureaus, TransUnion, Experian, and Equifax.
How your credit score is calculated is based on a (somewhat) secret combination of roughly five factors, including:
- Length of your credit history.
- Percentage of debts paid on time.
- Amount of available credit you’ve used.
- Types of credit you’ve used.
- Number of new credit inquiries.
Credit scoring leaves no room for mistakes
The methods of determining creditworthiness have been long been subject to debate. The traditional system only takes debts into account, which means timely rent and bill payment don’t have a big effect on your score. Let that sink in for a minute. According to FICO’s traditional system, prompt bill payment for your entire adult life doesn’t equate to how responsible you’ll be as a borrower.
Additionally, derogatory marks have long lasting consequences in the traditional system. Late payments, for instance, typically remain on your credit report for seven years. That’s a long punishment for being a few days late on a single credit card payment. And if that delinquency is sent to collections, it becomes a bigger problem. Once a bill is sold to collections, the damage is done and can’t be undone. Paying the collections agency has no positive effect on your score.
New approaches to credit scoring help borrowers
The good news is that changes to credit reporting and scoring have already begun. In 2010, Experian became the first credit reporting agency to consider rental history in their reports. What could be a better indicator that you’re likely to pay your mortgage on time every month than your positive rental history?
Even more promising is FICO’s changes to how it looks at late payments. As it turns out, medical bills are the most frequent debt to go delinquent or be paid late. And understandably so. Medical bills can pile up fast, often creating immense financial burden. The new FICO program will still note late medical bill payments, but they’ll be considered a lesser offense than late credit card payments.
Lenders are also adjusting how they consider potential borrowers. More consideration is being given to work history, education, and income. It may sound strange but credit reporting agencies pay no attention to how much money you make, your earning potential, or how much you have socked away in savings. So far, they’ve only looked at how and when you’ve paid back debt in the past. Thorough financial history research from lenders provides a more accurate status of potential borrowers.
Lenders and credit reporters are working to correct flaws in the system so they can give millions of often overlooked, responsible people the chance to invest in their future by becoming homeowners. What do you think about the changes happening in credit reports and mortgage eligibility? Let us know on Facebook or Twitter! Are you ready to speak to a mortgage professional about your next home? Get in touch with us!
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