Fair Isaac Corp. says the latest update to its widely used credit scoring system will likely widen the gap between the number of borrowers with sterling credit and those with spotty records.
Though FICO says the changes will be modest for most consumers, it could mean added pressure on subprime borrowers while customers with FICO scores above 680 will likely see an increase in scores.
Credit scores generated with the new system will be more accurate than ever before, FICO says, due to the inclusion of so-called trended credit bureau data. This will allow auto lenders to more accurately assess the credit risk of certain consumers. Roughly 110 million Americans could experience changes to their credit scores under the new model.
Joanne Gaskin, vice president of scores and analytics at FICO, says the improved predictive power will boost auto loan originations for lenders without increasing the risk of default.
“Uncertainty leads to credit typically tightening,” Gaskin said. “Everyone’s looking to find a way to successfully grant credit that’s a win-win for the lender and the consumer.”
FICO updates its scoring model every five years, according to the Silicon Valley company. The latest iteration reflects certain market changes such as the rise of personal loans and the application of alternative data in traditional scoring processes.
FICO scores typically range from 300 to 850.
Lenders may be concerned, as The Wall Street Journal reported, that using alternative data and other factors to compile credit profiles may adversely skew consumer credit scores. Determining that customers are more creditworthy then they are could result in higher delinquencies for lenders and possibly repossessions.
FICO, however, denies its scores are artificially inflated, maintaining that a steady increase in credit scores across credit tiers is tied more closely to the ongoing economic expansion, job growth and income gains than scoring miscalculations. Shifts in market factors outside a borrower’s credit file, such as unemployment rates and lender underwriting practices, also play a role in evaluating consumers’ repayment risks, FICO says.
Credit shifts
Changes to customers’ credit scores under the latest scoring system will be moderate, according to the company.
Negative credit activity, such as a recent delinquency or high credit utilization, will likely lower scores, FICO says, while paying off debt quickly will result in higher scores than previous versions.
Roughly 40 million people will see an increase in credit scores of over 20 points with the new system, while another 40 million will see scores drop more than 20 points, “properly reflecting their credit risk,” Gaskin said.
Relative to the previous system, an auto lender could approve up to 3 percent more loan applications with a constant default rate, the company said. Alternatively, the system could reduce the default rate by as much as 9 percent.
Still, auto lenders have options. Some may stick with previous iterations of FICO’s scoring or work with a competitor such as VantageScore. Gaskin said most auto lenders use the FICO Score 8, released in 2009.
“It really becomes a business decision by the lender to make that move,” Gaskin said. “What’s the expense associated with the transition versus what is the potential increase we can see in predictive lift and can we book more consumers?”
Implementing the new system will also take time. The model will be available to lenders through U.S. credit reporting agencies starting this summer. Because the process of onboarding new scoring and regulatory procedures can be lengthy, Gaskin predicts most lenders and dealers will have gravitated to the new system by 2022.
