FICO 08 - Understanding the “New” Credit Scores

FICO 08 is coming! FICO 08 is coming! Ready or not, the method which credit bureaus use to determine credit scores is about to change.

Fair Isaac and Co. is introducing FICO 08, an improved scoring model designed to help lenders make a more accurate assessment of risk when accessing applicants. In light of increasing levels of delinquencies, as well as declining recovery values (the amount a lender is able to recover after a reposed vehicle is sold at auction), lenders have been looking for a better model to predict the likelihood of a loan default. According to Fair Isaac, FICO 08 should help lenders reduce their default rates by 5-15%

The fundamental elements that FICO evaluates in computing a credit score will remain largely look and feel the same. Lenders and creditors will continue to look at:

• Payment history: Has the consumer consistently paid their accounts on time in accordance with the terms of their loan or credit arrangement?
• Available credit: What is the total amount of credit currently available to the consumer?
• Credit utilization: How much of the total credit available is currently being used?
• Credit balances: What is the total of current and delinquent account balances?
• Depth of credit: How long is the person’s credit history and what is the mix of credit types?
• Recent credit: How many recently opened credit accounts and credit inquiries are on file?

What will change is how the new scoring system views these elements. FICO 08 will more finely “slice and dice” information, and will do a better job separating the good risks from the bad ones, particularly with regard to subprime borrowers. By dividing the population into 12 segments (8 for “good” credit and 4 for “bad”) instead of the current 10, FICO 08 hopes to make the scoring system more accurate, and lower the risk of assigning a consumer to the wrong segment.

Additionally, FICO 08 will better identify young or thin credit files, who may now have high scores even though they have relatively few accounts, many recently opened. Consumers actively seeking new credit will be more easily identified, allowing creditors to more accurately gauge the potential risk in granting too many new accounts at once.

The major differences will be in how FICO 08 looks at credit files. More points will be given to consumers who maintain a variety of credit, such as a credit card or revolving account, as well as an installment loan or mortgage. This, accord to Fair Isaac, shows that the consumer can manage multiple payments on different kinds of accounts. Additionally, FICO 08 will penalize borrowers who use a high percentage of their available credit. Accounts at or near their limits will generate a lower score for consumers.

The way that FICO 08 will treat delinquent credit will be different as well. It will be harder on “repeat offenders”, those consumers who are consistently delinquent on their accounts, as opposed to those with only an occasional slip up. Consumers who have a number of accounts currently past due will be viewed harsher than a consumer with only one account delinquent, with other accounts current or up to date. A consumer with only one derogatory or delinquent account won’t be dinged as hard as someone who has a number of accounts past due, and in fact, may generate a higher score for a consumer in arrears in one account who also has a number of accounts in good standing. However, FICO 08 will draw a greater distinction for serious delinquencies over 90 days late. Multiple delinquent accounts could significantly lower a consumer’s score.

Perhaps the most significant change coming is that FICO 08 will no longer consider “authorized users” in computing a credit score. This is in response to curtail the use of “credit sharing”, where a creditor with a low score is added to an account of a non-related consumer in an effort to boost the first consumer’s score. In effect, authorized users with no credit history of their own could see their credit score disappear.

Consumers who are accessed as a “lower” risk under FICO 08 may start to get better terms from creditors. A consumer deemed to be a “higher” risk under the new scoring system may find less than favorable terms, or may find it tougher to even get credit. Consumers who occasionally mess up, have a good mix of credit types, with a single delinquent account may actually see their credit scores rise, while consumers who consistently mess up, have balances at or near their credit limits, are 90 days late on multiple accounts or have authorized user accounts in their file, may see their credit scores drop. Additionally, FICO 08 will not “ding” a credit score for multiple related credit inquiries. A consumer shopping for a mortgage or an auto loan who applies to multiple lenders will not see their score drop because of the inquiries.

SO, when will FICO 08 come into play? Experian is expected to begin using the FICO 08 in the first quarter of 2008, while TransUnion believes they will be ready by the second quarter of 2008. At this time, Equifax has declined to offer FICO 08 due to litigation regarding “VantageScore”, which is a joint venture, started by all three bureaus in 2006, to compete with Fair Isaac's FICO scoring system. The lawsuit, filed by Fair Isaac, is based on unfair and anti-competitive practices which are meant to harm the FICO brand. The legal action has caused Equifax’s relationship with Fair Isaac to remain "strained" until the lawsuit is resolved, says David Rubinger, Equifax spokesman, as quoted in the December 19th, 2007 edition of the Wall Street Journal,

Regardless of when FICO 08 is implemented, consumers may not see a significant difference in their scores. According to Tom Quinn, Vice President of Global Scoring Solutions for Fair Isaac, as quoted in the December 19th, 2007 edition of the Wall Street Journal, "Overall, more consumers will see their FICO scores go up slightly than will see their scores drop."