"Archaic" FICO Model Called Out by NAR. Credit Scoring Due Another Update
The National Association of
Realtors® recently called on Fair Isaac Corp., developer of the FICO score
model, to revise some of its computations to take into account the negative
impact on consumers when banks and credit card companies unilaterally reduce or
cancel credit lines, even when consumers are in good standing on those
accounts. An NAR spokesman said that
FICO's software is "unable to differentiate between innocent victims and
people whose behavior genuinely merits reductions," and called the FICO
model "archaic."
It has been a while since FICO
made any substantive changes in their model.
The last time it rolled out a new formula, in Spring 2008, was in reaction
to a rising level of delinquencies - a precursor of things yet to come - and the
probably to the inauguration of a new scoring model developed by the three
credit bureaus who had been watching FICO's success in marketing credit scores
to consumers. At the time the changes
were announced, FICO predicted that its new scoring system would help lenders
reduce the default rates on consumer loans between 5 and 15 percent while
actually raising the scores of some consumers.
Utilization was not among the
areas involved in those changes. The
most sweeping tweak was a response to a perfectly legal but incredibly devious
credit repair scheme called "piggy backing." An account holder can name another party as an
"authorized user" on a credit card and it was a long time strategy
for parents to put a child's name on an account which automatically transferred
some of the parent's credit history to the child, giving him a leg up in
establishing his own credit. Wives often
access their husband's accounts as authorized users as well, rather than becoming
co-borrowers or joint owners of the account.
However, FICO found that credit
repair agencies were soliciting persons with high credit scores to sponsor
total strangers as authorized users; in effect, paying these sponsors to rent
out their credit rating. The users
gained a credit history but not the ability to actually use the card or any
access to the sponsor's personal information. After a few months the piggy
backer was removed from the card and the sponsor's credit could be rented out
to another credit repair customer. There
were stories of sponsors who made as much as $10,000 per month through such
programs. Privacy and credit laws made
it impossible for a lender to get personal information about the authorized
user so FICO changed
the scoring model so it no longer recognized authorized user accounts in scoring
and eliminated the automatic boost in the credit score of the piggy-backing
consumer.
FICO also changed the way
it treated delinquencies. An individual
who was seriously delinquent - over 90 days - on a single major account while
maintaining his other accounts in good standing was likely to see his score increase
under the new rules. However, one who
demonstrated a pattern of late payments on multiple accounts probably saw his score
go down. At the time the change was
announced FICO said this change could alter an individual's credit score by 20
to 25 points - in one direction or the other.
FICO scores are calculated
by weighting several factors from an individual's credit report. The credit history, which is the main focus
of a credit report, accounts for only 35 percent of a FICO score. Given almost
equal weight (30 percent) is the utilization of credit. This is the percentage of credit an
individual has used relative to the amount that is available. A consumer with $10,000 in open lines of
credit but only $2000 in debt will score higher in this category than one who
has used $9,000 of the available credit.
The length of time an
individual has had credit counts for 15 percent of the total score. A consumer who opened his first department
store charge account in 1985 will score higher than one who first got credit in
2009.
The last two categories,
each of which count for 10 percent of the score, are the number of times the
individual has applied for new credit in the recent past (the 2008 changes also
included a tweak to this to allow for consumer "shopping") and the
diversity of the types of credit in a portfolio.
FICO has always been cagey
about average credit scores - occasionally publishing score ranges. A comparison between the 2005 figures - the last
we could find - and the present ranges would be informative. In 2005, MND reported:
"Approximately 1 percent of
the population with established credit has credit scores below 500 and another
13 percent score from 500 to 600. By far the largest group, 28 percent, is in
the 750 to 799 scoring range. About 11 percent of the population is in that
rarified area above 800 points. The median credit score (the point where 50
percent rank higher and 50 percent rank lower) is 723.
But back to the NAR's complaint. The
Association wants FICO to either totally disregard the utilization rate for consumers
who had a reduction or tabulate the score as if the reduction had not taken
place.
While FICO has not publicly responded to NAR, they did conduct a study
late last year on the subject of credit line reductions. Their analysis shows that approximately 14
percent of the U.S. consumer credit population experienced a reduction in total
revolving credit between April 2009 and October 2009. Four percent had a
risk trigger such as a late payment while 10 percent did not. FICO found that among the latter group, the
affected consumers already tended to be very low-risk with a median FICO score
of 757 and low balances and credit utilization ratios. As a result, small reductions in their total
revolving credit lines had a minimal effect on their FICO scores. The average reduction was $4,800; about 12
percent of the average revolving credit available to this population, and the
reduction resulted in average change in utilization from 24 percent to 27
percent between April and October 2009.
FICO said it observed very limited impact on scores for the no-risk triggers
group. Their median FICO scores in fact
increased slightly (from 755 to 757) during the period.