Credit Scoring 2.0

Now that everyone is obsessed with their credit score, the scoring agencies are upping the ante. Version 1.0 of the credit scoring models captured data about consumer debt, mortgages, public records and collections.

The new scores, which have not been rolled out yet, will include information about payday loans, evictions, and child support obligations. Payment histories for cell phones, rent and utilities will most likely be added in the near future.

Credit scoring has been around since the 1960s but has only been used in mortgage lending since the 1990s. In lending, a credit score predicts the likelihood that a borrower will default on a loan. For example, if your credit score is below 550, there is a 70 percent chance you will default on a loan. If your score is over 800, the chance drops to 1 percent.

Credit scores are primarily used for lending, but they are starting to be used for other purposes. Looking for a new job? A prospective employer may pull your credit report. Shopping for insurance? Insurance companies look at your credit history as a way to identify risky behavior or life changes that may lead to an incidence of higher claims.

Managing your credit is pretty easy. The first step is to get a credit report. Go to www.annualcreditreport.com for a free report. This is the only site that will give you a free report, no questions asked. You can get a free report from each of the three credit bureaus once per year. I recommend pulling one from each bureau every four months so you can keep track of your credit history on a regular basis.  Once you see what you’re dealing with, here are some quick tips to improve your score:

• Pay your bills on time and bring delinquent accounts current.

• Pay collections and judgments; ask to have the item removed by the collection agency. It probably won’t happen, but it’s worth asking.

• Do not close old accounts. Old accounts give depth to your credit profile.

• Keep your revolving accounts (credit cards and lines of credit) at less than 30 percent of your credit limit. Over-utilizing credit will really hurt your score, and the magic number is 30 percent of the limit.

• Limit credit inquiries. Only apply for credit when it’s needed.

The proposed scoring “enhancements” are meant to give lenders more information about borrowers that may not use traditional credit. Reading between the lines, I think the scoring companies are looking for ways to enhance the predictability of the scores for all borrowers by capturing as much information as they can. Regardless, the formula just got more complicated, so proceed accordingly.