It’s been almost a decade since the Fair Isaac Corporation changed the formula to their popular and widely used FICO credit score model, and apparently a decade is quite long enough. Fair Isaac is preparing to roll out its new credit scoring formula—aptly titled FICO 08—this spring, an accelerated date, in order to help lenders improve their risk management in the wake of rising loan defaults.
Fair Isaac predicts the new formula will reduce default rates on consumer credit between 5 percent and 15 percent, according to the Wall Street Journal. Lenders have been increasingly needy of a more accurate measurement of credit risk as defaults continue to build up because of subprime mortgages and falling housing prices.
“Higher-risk borrowers may find it tougher to get credit, while those with less-risky profiles—though they may have gotten approved for credit accounts in the past—will start to get better deals from lenders,” according to the Wall Street Journal.
The FICO scoring system, which is used by 90 percent of the country’s 100 largest banks, won’t be tampering with the scoring range of 300 to 850, or with things such as timely payments, length of credit history and amount of debt, among other things. There are some changes investors should be aware of, however.
Most notably, FICO 08 will eliminate authorized users; see our previous article Credit Boom Turned Credit Bust for more information. While the old system would allow spouses and children of primary card-holders to become authorized users and build their own credit histories, lenders felt the practice undermined their attempts to contain credit risk, according to Mortgage News Daily.
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The move was largely in response to the creation of credit-repair websites that would allow consumers with bad credit to become authorized users on the account of a stranger with a good credit history. It will, however, hurt those spouses and children of card-holders who legitimately used the practice to build their own credit.
Additionally, FICO 08 will give more credit points to consumers who maintain multiple lines of credit, such as a credit card, auto loan and home loan, while penalizing more heavily those people who use a lot of their available credit, according to the Wall Street Journal.
The new system will also go easier on consumers with an occasional slip-up in payment and come down much harder on those with multiple credit infractions. The new system is intended to be more precise in determining good and bad risk borrowers, especially among subprime borrowers and those seeking or just establishing credit.
Although it seems like the FICO 08 scoring system will be much tougher, the average credit-holder may be pleasantly surprised.
“Overall, more consumers will see their FICO scores go up slightly than will see their scores drop,” Tom Quinn, vice president of global scoring solutions for Fair Isaac, said in a press release.
Investors should take note of Fair Isaac’s changes in the scoring system and expect to see it go into effect in the coming months as the major credit reporting agencies adopt it. Fair Isaac has already given FICO 08 to Experian and TransUnion plans to implement the new system sometime in the second quarter of this year.
The third major credit reporting agency, Equifax, is in the midst of a lawsuit with Fair Isaac about competition from a new system, VantageScore, and plans not to move forward with FICO 08 at this point in time, according to the Wall Street Journal. Fair Isaac maintains that it will distribute the formula to all three agencies.