The FICO credit score could change this year, thanks to updates made by Fair Isaac, the company behind the scoring system. According to FICO, approximately 110 million people will experience an adjustment to their credit score of around 20 points either up or down. But whether a score increases or decreases depends on the score itself as well as on general financial behavior.
The biggest adjustment involves the heavier weight placed on payments and debt ratio, so consistently paying late or having a lot of debt will create a noticeable change in personal credit scores. The new score will also look at individual debt trends and payment history as far as two years back, so it’s important to work on improving these factors starting now, before the new score comes into effect later this year.
FICO Score 10, this latest version, is likely to have the greatest effect on individuals with scores around the 600 mark. If it’s in the lower end of the 600s, poor debt management might send it down; if in the upper 600s, timely debt repayments could actually improve credit score. The truth is, almost a quarter of already fundable SMBs likely won’t be affected at all by this FICO change — but what about the other 75%?
How will the new FICO update affect small business lending?
The effect of the FICO update on a business’s fundability really depends on the lender itself — how much emphasis it puts on credit score and also which version of FICO it actually relies on. Different financial institutions often choose to use different FICO versions, which could lead to some inconsistencies in the system. Every few years, FICO adjusts its scoring methodology but that doesn’t mean the new model is automatically adopted by lenders. FICO 8 from 2009 is still being used in the industry.
While small business lenders do take personal credit score into account when making funding decisions, it’s by no means the driving force to get a loan. For alternative or online lenders, credit score is merely one factor out of many used to determine the overall financial health of a business. Factors such as business age, monthly deposits, bank balance, monthly revenue, non-sufficient funds (NSF), negative balance days, and existing business loans also play an important role. That said, however, it’s still crucial for a business owner to improve a poor credit score or maintain a good one, as this could be the tipping point to help them become fundable and even access better funding options. Being cognizant of the various factors that impact a credit score is essential, as making just a few small improvements on each of these factors could have a significant effect on the overall score and ultimately on a business’s fundability.
3 Tips to help SMBs improve their new FICO score
A credit score is affected by many factors and improving a few key ones could positively affect a credit score. The most important factors impacting FICO 10 are:
1. Payment History
Payment history is cited as one of the main updates in the FICO 10 model. Payment history is determined by the percentage of payments made on time, and missing payments can render a payment history negative, which is detrimental to a credit score. On the old FICO model, just one 30-day late payment could decrease a good credit score by 90-110 points, and FICO 10 will have an even greater impact.
Steps to take:
- Pay bills on time. Something as small as missing one payment could weaken credit score.
- If payments have been missed, it’s important to get current. The longer they are delayed, the worse a score will become.
- Setting up payment reminders is an effective way to ensure timely payments (some banks offer this, or simply make personal calendar reminders).
- Having payments automatically debited to a bank account is a guaranteed way to never miss a payment.
- A reputable credit counseling service can assist with any money trouble.
2. Credit Card Use
Maxing out credit cards or leaving some of the balance unpaid will hurt “credit utilization rate” (the ratio between what an individual owes and their credit limit for various credit cards and lines of credit), and in turn, harm the credit score. It also takes into account the amount owed on installment loans, but credit utilization rates shouldn’t be neglected.
Steps to take:
- It’s important to pay attention to the utilization rate on individual credit card accounts (not just the overall average rate). Having many accounts with a poor credit utilization rate will mark those seeking loans as “risky” to lenders.
- Paying down any existing debt can help improve the overall credit utilization rate.
- Due to credit card issuers reporting to the bureaus at the same time monthly statements are sent, a high utilization rate may be hard to maintain, but making earlier payments will help secure a high utilization rate.
3. Derogatory Marks
Being stuck in a sticky situation and finding it hard to make payments on time could wind one up with a very public record, such as a tax lien or foreclosure. One of these can plague credit with what’s known as a ‘derogatory mark’. These marks can also end up on a report in the case of bankruptcy or a civil judgment.
Steps to take:
- Going through monthly cash flow statements and deducting the necessary monthly bills first (e.g. water, electricity, food etc.) will allow you to see exactly how much money is left to play with.
- It’s a good idea to put more money toward debt reduction – be it decluttering the house and selling items on eBay, starting an extra side-gig to bring home more cash, or using cash in rewards from credit cards. No matter the method, putting money in a debt-saving piggy bank is a wise idea.
- Arranging debts from smallest to largest – paying off the smallest ones first will psychologically give a triumphant feeling. It may, however, be wiser to pay less interest over time, to organize debts so that those with the highest interest rates are at the top and to pay the minimum balance on the other debts.
Key Takeaway
Even though credit score is just one of multiple factors taken into account by business lenders, a business owner should consistently track and nurture it, particularly in light of the latest FICO update. Not only will increasing credit score help a business improve its fundability and funding options, but can also cultivate good financial habits, which ultimately have a positive impact on a business’s overall financial health.