Fair Isaac Corporation, developer of the formula that determines your FICO score, is presenting a new model with TransUnion, one of the three major credit agencies, dubbed FICO 08. The new formula comes almost a decade since Fair Isaac changed the formula and at a time when more lenders have criticized FICO’s ability to predict defaults as they continue to deal with falling housing prices and the subprime mortgage crisis. Equifax is expected to follow in the second quarter, while Experian is not commenting due to pending litigation.
With 90% of U.S. banks using the FICO scoring system, many things will remain unchanged, including the importance of timely payments, length of credit history, amount of debt and a scoring range of 300 to 850. The new system will provide a more thorough analysis of subprime borrowers and those with fresh credit histories, do a better job of predicting defaults and be more forgiving of one-time missteps. However, repeat offenders will be dealt with more harshly.
FICO 08 will continue to factor in account activity of authorized users, as well. Additionally, FICO 08 will give more 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 higher percentage of their available credit. Overall, Fair Isaac predicts the new system will improve the accuracy of lending decisions by as much as 15%.
Fair Isaac originally planned to exclude authorized users to curtail abuse by “credit repair” services that offer a boost to people with poor credit. Also known as “piggybacking”, a person can be added as an authorized user on an account held by a complete stranger with better credit to improve their FICO score. The new model will still help legitimate authorized users improve their credit score, but it will provide added security to protect lenders from people who are attempting to cheat the scoring system.
“More consumers with accounts in good standing should also see their scores increase slightly,” says Tom Quinn, vice president of global scoring solutions at Fair Isaac. “What we’re seeing in all of our analysis is that the model is doing what it’s supposed to do, which is to rank-order risk,” says Mr. Quinn.
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. But it may take awhile for the changes to be noticed or for consumers to see where they fall in the new system and possibly years before the score is widely available to consumers.
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