Fair Isaac Announces Changes to its Credit Scoring Formula
The credit scoring system is being modified yet again as Fair Isaac Corporation, developer of the FICO credit score rolls out a new model dubbed FICO 08. The third formula “upgrade” that Fair Isaac has released since inception, it’s hard to predict how long it will be (if at all) before FICO 08 is embraced by lenders and subsequently used on a widespread basis.
A demand by users for a better way of analyzing risk in the wake of rising mortgage defaults and consumer credit delinquencies has pushed Fair Isaac Company into speeding up the release of the revised formula. Of the three major credit reporting bureaus, Experian and TransUnion indicate that they will likely offer FICO 08 to lenders by the second quarter of 08. Due to the pending litigation between the credit bureaus and Fair Isaac regarding the VantageScore system, Equifax has announced it will not offer the new version of the FICO score until the lawsuit is resolved.
FICO 08 will have the same numerical range as the current FICO scoring system, 300 to 850, with higher scores indicative of lower credit risk. According to Fair Isaac, FICO 08 should result in a minimal increase for most consumer’s credit scores as compared with the current FICO system. They say the new FICO 08 formula takes a more refined look at people who have credit problems, giving some leniancy to those consumers who had only experienced one serious credit setback. As long as their other active credit accounts are in good standing, a single charge-off or repossession for instance will not hurt them as significantly as it does under the classic FICO scoring formula.
A summary of the major differences in the FICO 08 Credit Scoring Formula:
- A “moderate” level of credit inquiries will be less detrimental
- High balances on existing credit cards may hurt more
- “Piggybacking” or “authorized user” loopholes will not be allowed
- Acively utilizing existing credit accounts will increase in importance
- A combination of installment and revolving credit accounts will be optimal
What does this all mean? FICO predicts that the new FICO 08 scoring system will help lenders reduce default rates on consumer loans between 5 and 15 percent. They indicate that FICO 08 should be less strict on consumers who make the occasional slip, while coming down harder on those with multiple offenses. For example, it will give a slightly higher score than previously to a borrower who is late on one payment obligation but current on multiple other accounts. Those with several delinquent accounts could find their credit score reduced.
The FICO 08 formula will still take into account the same factors as the classic version namely on-time payment history, length of credit history, amount of debt, ratio of debt to available credit, type of debt, and any excessive amount of recent new credit (of course definition of excessive is unclear). One will also receive a higher score for the “optimum” mixture of credit debt. For example, a consumer with both revolving and installment credit will score higher than one with strictly credit card (or revolving) debt.
Another signficant change in FICO 08 involves the practice of “authorized users.” An authorized user is a consumer who is not responsible for paying a credit card, but that card’s history is reported on the user’s credit as well as on the owner’s credit. It is a common practice for parents to make children authorized users of their cards in order to help them build credit. Additionally, many spouses obtain the bulk of their credit histories from being authorized users of their husband’s or wife’s card.
In summary, the jury is still out as to whether the revised FICO 08 credit score will become the industry standard for lenders anytime soon, but be aware of the potential changes that may affect your credit rating at some point in the (perhaps not so distant) future.