Does Your Credit Score Say Who You Are?
Fair Isaacs Corp released some disturbing information that makes you wonder about the financial services industry’s use of your credit score for credit. Believe it or not, consumers with high FICO scores, between 760 – 789, were more likely to default on their home loan than their unsecured credit card debt.
According to the analysis in FICO Score Trends, recent repayment behavior across the financial services industry has shifted significantly from historical trends. This creates the perception that credit scores aren’t as accurate as they used to be.
In 2008-2009, bankcard accounts were just 1.6 times more likely to become 90 days delinquent than were mortgage loans. By comparison, in 2005 bankcard accounts were more than three times more likely to become 90 days delinquent. And for borrowers scoring high on the FICO® score’s 300-850 score range, the level of repayment risk actually has become greater for real estate loans than for bankcards. In 2009, 0.3 percent of consumers with between 760 – 789 defaulted on real estate loans, compared to 0.1 percent who defaulted on bankcards.
FICO CEO Mark Greene said that the reversal of a long-held tenet came about not only because of the bad economy but also because of counterintuitive trends in consumer behavior.
FICO scores help lenders make accurate, reliable and fast credit risk decisions when consumers apply for a mortgage or credit card. What are the factors behind the credit score? They take into account consumer payment history that includes adverse public records; amount of debt owed; length of credit history; credit limits; and types of credit used.
The two given the most weight are adverse public records and amounts owed. Both account for about 60 percent of the total.
As the most widely used broad-based risk scores, FICO scores play a critical role in billions of decisions each year. Originally released in the US, FICO scores are now deployed in 21 countries. FICO 08, the latest US version, increases predictive accuracy by up to 15%, especially for consumers who have recently sought new credit and those with prior credit blemishes.
While the FICO 8 score continues to prove its unprecedented power in rank-ordering consumers for risk, even low-risk consumers are changing the value they give different credit lines. As the CARD Act goes into effect next week, it likely will create additional, unhelpful pressures on the banking business.
What can you do to raise your credit score?
- Pay your bills on time
- Don’t keep high balances
- Borrow only when necessary (Think twice before opening a new card or line of credit)
- Cut your balance outstanding because your score is based on the gap between your total balances and your total credit line, not the credit line itself.
Right now, Fair Isaac’s latest scoring model, FICO 8, is being rolled out to lenders. Unfortunately, it’s based mostly on loans made before the crisis. FICO 08, the latest US version, increases predictive accuracy by up to 15%, especially for consumers who have recently sought new credit and those with prior credit blemishes.
However, if consumers with great credit scores are defaulting more often than expected on their real estate loans, how can lenders rely on the scores?
In the height of the real estate boom, lenders such as subprime lenders approved mortgages based solely on a consumer’s credit score. Lenders did this as fast as they could, because volume was key to their success, and nobody wanted to be left holding those no-doc loans when they went bad.
Fair Isaacs said that the score isn’t a tool to reward you or penalize your past behavior. It’s more to take what you’ve done and predict (behavior) based on that. After all, credit scores are based on history, and history has changed!
SOURCES: Federal Reserve Bank of Philadelphia; Fair Isaac Corp.