The way some credit scores are calculated is about to change – and it could mean that bigger changes are on the way soon.
VantageScore, the nation’s second-most-prominent credit-scoring firm (behind long-time industry leader FICO), announced changes to its scoring formula last month. The most important change is the inclusion of so-called “trending data” in the formula, and it is likely the start of something big.
Until now, a credit score has typically been a snapshot of a moment in time. The credit-scoring formula uses information in your current credit report – how much you owe, how much available credit you have, how many late payments you’ve made and so on – to assign you a score. That score, ranging from 300 to 850 for both VantageScore and FICO, is intended to show your risk as a borrower. If your score is 550, you’re probably pretty risky. If your score is 750, you’re probably not.
VantageScore 4.0, the latest version of the credit-scoring formula, which will be available this fall, will incorporate trending data into its calculations. That means that the score will no longer be a single snapshot but rather a more insightful, detailed view of your ability to handle credit and debts responsibly.
Here’s an example:
Say you’re about to apply for a mortgage and have about $5,000 in credit card debt. If you once had $10,000 in debt but have diligently chipped away at it in recent months – paying on time, every time – and gotten that debt down to just $5,000, the scoring formula will likely reward you for your efforts. That downward trajectory for your debt makes you look more responsible and less risky to the formula. On the flip side, the formula won’t take as kindly to that $5,000 in debt if it has instead grown from just $500 in recent months. The formula will view that as a danger sign and may ding your score accordingly.
While this trended data is new to credit-scoring formulas, it has been made available to lenders for several years. It’s especially prevalent in the mortgage business because mortgage financing giant Fannie Mae last year required mortgage lenders to incorporate trended data into their lending decisions.
Still, FICO – the company synonymous with credit scoring for decades and still claims to be used by 90 percent of top lenders – has yet to incorporate trending data into its primary formula. It is likely just a matter of time until it does, however. VantageScore claims that incorporating trended data has made its formula 20 percent more predictive, and if that number is accurate, it’s hard to imagine FICO not jumping in. That’s when we’ll see this shift toward trending data really take hold.
The move toward trending data isn’t the only shift that’s coming to VantageScore. Version 4.0 will also incorporate changes from the National Consumer Assistance Plan, a joint effort by credit bureaus TransUnion, Equifax and Experian to make credit reports more accurate and easier to read. These include the removal of medical collections that have been paid, or are being paid, by insurance as well as the removal of certain tax liens and civil judgments that don’t include sufficiently complete data, such as a person’s name, Social Security number and date of birth.
The bottom line: While these changes are significant, they don’t change the basic fundamentals of credit scoring. If you pay your bills on time every time, keep your balances low and refrain from applying for too much credit too often, your credit is going to be just fine regardless of whether credit-scoring formulas rely on trends or snapshots.
Matt Schulz is the senior industry analyst at CreditCards.com, a site dedicated to helping people make smart decisions about obtaining and using credit. You can follow him on Twitter at @matthewschulz.