Fair Isaac Corporation, the Minneapolis-based company that invented the credit score, faced a quandary earlier this decade.
With the recession deepening, and consumer spending and debt-paying patterns changing, the company decided to give its flagship product, the FICO score, a tune-up, so the score’s predictive models would be sharpened against the toughest economic conditions since the great depression.
The company’s data picked up a growing distinction between consumers who started paying late on a handful of credit lines (known as “tradelines” in the credit reporting industry) “not simply because they were bad borrowers but because they were sloppy payers,” explained Joanne Gaskin, director of mortgage scoring solutions at Fair Isaac.
But the company wanted to be able to predict whether a consumer would pay late on an occasional basis on one or two tradelines or would go delinquent across the board.
It was the eighth such revision of the FICO credit scoring model, and when the FICO 8 Score was launched in 2009, the company said it improved its credit risk prediction by 15 percent.
Which might work for general credit, but when it comes to approving mortgages, lenders have become so conservative that they wanted even more detailed information about whether someone might default specifically on a mortgage or home equity line of credit, while continuing to pay a credit card debt on time.
Gaskin said FICO had already created a specific scoring model for those consumers who are shopping around for an auto loan or a credit card. In October, they introduced the FICO 8 Mortgage Score, to help lenders more easily predict consumer behavior no matter what happens in the economy.
In creating the FICO 8 and FICO 8 Mortgage Score, Gaskin said the company took a deeper look at the following issues, and refined their impact on the credit scoring model:
- Authorized users. During the housing boom, Fair Isaac saw mortgage application abuse associated with authorized users. “Consumers were adding someone who wasn’t a relative to a tradeline as an authorized user, known as ‘piggybacking’,” she explained, sometimes paying as much as $1,000 to $2,000 to buy that positive credit history. The new scoring model allows lenders to take a more thorough look at when that authorized user was established to better determine credit risk.
- Loan Modifications. Fair Isaac has worked with the Consumer Data Industry Association (CDIA) on implementing two new credit history codes that relate to loan modifications. “CN” refers to a permanent government loan modification and “CO” refers to a permanent non-government loan modification. According to Gaskin, these are brand new codes to signify that a loan modification that has taken place, but neither will be considered “derogatory” by the FICO score. Unfortunately, during the loan modification process, a homeowner’s credit might have been damaged by the way their lender reported their payments, she said, adding “We continue to work with Treasury and CDIA to make sure the right codes are being used.”
- Economic impact. How do you take what you know today and predict the future? Gaskin said that the FICO 8 has incorporated economic forecasting based on Moody’s Economy.com six macroeconomic outlook alternative scenarios, which ranges from a stronger recovery to a fiscal crisis where the dollar crashes and you have hyper-inflation. “Incorporating macroeconomic data allows lenders to adjust their policies. We see it as the next wave of predictive analytics,” she noted.
Gaskin said one of the most interesting things about credit and the recession is that the median FICO credit score remains 712. But the score distribution has changed.
“When you go into an economic downturn, those consumers who score higher in the FICO Score ranges move higher yet, and those in the lower bands move further down the chart,” Gaskin observed.
She said the interesting idea is that consumers who manage credit well and have higher scores tend to get more conservative with their finances so they move further up in the score distribution. Those who are in trouble financially will get hurt worse by an economic downturn, and so their credit scores will drop further.
Since the FICO 8 Mortgage Score looks at credit a little differently, the median score is around 760, or significantly higher than the median FICO 8 Score. What that shows, Gaskin said, is that the vast majority of Americans pay their mortgages “as agreed.”
“There’s just a lot of [media] coverage about the 10 percent that are not paying as agreed,” she added.