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davidlerner.com > Debt  > A Major Change in How Credit Scores are Calculated

A Major Change in How Credit Scores are Calculated

In an economy that is driven by debt in many ways, it is a way of life for most Americans. Overall U.S. household debt has increased by 11% in the past decade, and today the average household with credit card debt has balances totaling $16,425. The average household with any kind of debt owes $135,924, including mortgages. 

If you’ve ever made a major purchase that required ongoing payments, then you’re familiar with the importance of your credit score, and how it can affect interest rates.

Your credit score is the number by which a lot of important transactions are decided. There are three minimum requirements to generate a FICO score. First, you need to have a credit file that reflects you are not deceased. Second, you must have at least one account open for six months or more. And third, you need to have at least one account that's been reported to the credit bureaus. 

However, there was recently a major change in the way that credit scores are calculated. The Federal Reserve Bank of New York found that the big reporting agencies, Equifax, Experian, and TransUnion, have started excluding certain items that used to be considered negative dings on our credit.

The New York Fed used anonymous data from Equifax and zeroed in on what are called collections accounts. These are tied to people with various debts that get passed on to a collections agency. 

These debts can be things like missed credit card payments or mortgage defaults. But these accounts have also included items some argue are unfair or prone to error such as unpaid traffic tickets, missed gym membership fees, even overdue library books.

In 2015, the big three credit reporting firms settled with 31 state attorneys general to clean up the process behind reporting missed payments by the second half of 2017.

Among the changes, credit reports can only include a debt if there’s been an actual contract or an agreement to pay, which would exclude traffic tickets. Medical debts that are less than 180 days old can't be reported either. 

Overall, the report shows that the number of people with at least one account in collections dropped by about 25 percent.

Among the findings:

    • Credit scores went up on average by about 11 points.
    • People with lower credit scores saw much bigger increases after the 2017 change.
      18% of people saw credit scores increase by more than 30 points.
    • After the second half of 2017, 8 million people had collections accounts completely removed from their credit reports.
    • Overall, the study found an $11 billion reduction in total collection account balances.

This could make a huge difference to anyone renting an apartment or home, buying a home, refinancing a student loan, qualifying for an auto loan, or any other credit score reliant process.

                                                                                            

IMPORTANT DISCLOSURES

Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable– we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances. Member FINRA & SIPC.

 

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