Prior to 1989, credit approval was subjective and time consuming. If an underwriter did not like the color of your hair, you might not be considered for your loan. Similarly, each individual's credit report had to be viewed and analyzed, which often added days or weeks to the loan process. All of that changed with the mathematical innovation known as credit scoring.
I contacted Chris Groppa, Account Supervisor for Fleishman-Hillard, Inc., as well as Ethan Dornhelm, scoring scientist for Fair Isaac. They have lots of information about a new scoring system known as FICO®08.
Mike: For those not sure what a FICO® score is, can you offer a mini background on FICO®?
Chris: First introduced in 1989, Fair Isaac's FICO® score has gained widespread acceptance as the industry-standard measure of consumer credit risk, enabling lenders to objectively and fairly extend financial opportunities to millions. Your FICO® score is calculated using the information in your credit reports. The median score is about 720 on FICO® scale of 300-850. The higher the FICO® score, the greater the likelihood of repayment. Credit reports contain all of the information that each credit bureau has on file about you. The information that the credit bureaus collect in your credit report includes your credit accounts, how many times lenders have requested information about your credit (inquiries), how many times lenders have turned your account over to a collection agency (collections), and certain legal items (such as bankruptcy filings, tax liens, and judgments).
Mike: Why is FICO® scoring important to the consumer?
Chris: Consumers who maintain a strong FICO® score can improve their ability to get lower interest rates on loans. A better FICO® score can also help them qualify for more favorable terms on an auto loan or mortgage refinance, lowering their monthly payments. That kind of help can be vitally important to millions of people facing financial challenges. Today, 90 of the largest 100 financial institutions, the 25 largest credit card issuers, and the 25 largest auto lenders rely on the FICO® score to help make lending decisions. U.S. businesses have used more than 100 billion FICO® credit scores to make smart decisions about their customers and prospects.
Mike: What is the rationale for change in FICO®08?
Chris: Since the introduction of its FICO® score in 1989, Fair Isaac has routinely redeveloped the scoring formula. FICO®08 is the company's latest update. Redeveloping the formula in this way keeps the scores attuned to consumers' credit habits. It also allows Fair Isaac to make changes to the model to meet lenders' needs, and it enables the introduction of technical innovations that significantly enhance the score's predictive power. The redeveloped FICO®08 score offers more refined risk prediction compared with prior versions. As a result, the formula provides significantly improved risk evaluation across the entire population of consumers. Fair Isaac is working closely with leading lenders and government regulators to help them understand how FICO®08 scores are addressing the changing needs of the industry.
Mike: How does FICO®08 differ from what has been the case?
Chris: The primary drivers of the FICO® score remain how consistently bills have been paid as agreed, and how responsibly debt has been managed (for example, by keeping credit card balances low relative to credit limits). That said, there are some changes in FICO®08 that could cause consumers to experience a shift in their FICO® scores.
- Missed payments - FICO®08 score will provide greater flexibility regarding missed payments. For borrowers who are in arrears on an account, their FICO®08 score will drop less if the borrower also has a number of other credit accounts in good standing. However, FICO®08 scores could drop farther if the consumers' credit reports show multiple delinquent accounts.
- Isolated delinquencies - FICO®08 score is less likely to penalize a single serious delinquency if it occurred two or more years ago on an otherwise unblemished credit history (no prior or subsequent delinquency). On the other hand, the FICO®08 score will likely drop further if the credit report shows both a serious delinquency and a pattern of multiple prior delinquencies.
- High credit usage - FICO®08 will be more affected by high credit usage. Consumers may receive lower scores if their reported balance on one or more credit card accounts is near the account's limit.
FICO®08 places increased emphasis on demonstrating the ability to successfully handle a variety of types of credit. As such, a consumer who has lengthy experience with a mix of both revolving (credit cards) and installment (auto loan, student loan, etc.) accounts that they have paid on time is likely to be viewed more favorably by FICO®08 than a consumer utilizing only a single type of credit account. In addition, a consumer whose credit report shows that a relatively larger number of open accounts that are being paid as agreed is likely to be viewed more favorably by FICO®08 than a consumer who has very few or no active credit accounts which demonstrate successful repayment history.
Mike: Is FICO®08 in place now and will consumers know which model is used?
Chris: Lenders purchase credit reports through one of the three national credit bureaus: TransUnion, Equifax, and Experian. Fair Isaac is working with the credit reporting agencies to make the FICO®08 score generally available to lenders as soon as possible. As we announced on January 29, 2009, with TransUnion, the score is now available for customer testing. It is scheduled to be available at Equifax in 2Q09. There is no specific timetable for a rollout with Experian but Fair Isaac continues to work with Experian to implement FICO®08 score.
FICO®08 will begin playing a role in consumers' ability to borrow once lenders adopt FICO®08 and begin using this score version to make lending decisions. There is no precise date that lenders will collectively switch to FICO®08; the amount of time that it takes for a lender to test a new score on its portfolio before it is ready to adopt the score varies widely. For some lenders, testing might take a few months, and for other lenders, the process could take more than a year. We certainly are encouraging lenders to migrate to using FICO®08 as soon as possible, and are providing our expertise and support to our clients to facilitate this transition.
Mike: How can people get their credit scores?
Chris: A lot of different credit scores are available online, but only the FICO® score is widely used by lenders. Consumers can get their FICO® scores at www.myFICO.com for $15.95 and also receive expert guidance to help manage credit.