"Archaic" FICO Model Called Out by NAR. Credit Scoring Due Another Update

The National Association ofrnRealtors® recently called on Fair Isaac Corp., developer of the FICO scorernmodel, to revise some of its computations to take into account the negativernimpact on consumers when banks and credit card companies unilaterally reduce orrncancel credit lines, even when consumers are in good standing on thosernaccounts.  An NAR spokesman said thatrnFICO’s software is “unable to differentiate between innocent victims andrnpeople whose behavior genuinely merits reductions,” and called the FICOrnmodel “archaic.”</p

It has been a while since FICOrnmade any substantive changes in their model. rnThe last time it rolled out a new formula, in Spring 2008, was in reactionrnto a rising level of delinquencies – a precursor of things yet to come – and thernprobably to the inauguration of a new scoring model developed by the threerncredit bureaus who had been watching FICO’s success in marketing credit scoresrnto consumers.  At the time the changesrnwere announced, FICO predicted that its new scoring system would help lendersrnreduce the default rates on consumer loans between 5 and 15 percent whilernactually raising the scores of some consumers. rn</p

Utilization was not among thernareas involved in those changes.  Thernmost sweeping tweak was a response to a perfectly legal but incredibly deviousrncredit repair scheme called “piggy backing.”  An account holder can name another party as anrn”authorized user” on a credit card and it was a long time strategyrnfor parents to put a child’s name on an account which automatically transferredrnsome of the parent’s credit history to the child, giving him a leg up inrnestablishing his own credit.  Wives oftenrnaccess their husband’s accounts as authorized users as well, rather than becomingrnco-borrowers or joint owners of the account.</p

However, FICO found that creditrnrepair agencies were soliciting persons with high credit scores to sponsorrntotal strangers as authorized users; in effect, paying these sponsors to rentrnout their credit rating.  The usersrngained a credit history but not the ability to actually use the card or anyrnaccess to the sponsor’s personal information. After a few months the piggyrnbacker was removed from the card and the sponsor’s credit could be rented outrnto another credit repair customer.  Therernwere stories of sponsors who made as much as $10,000 per month through suchrnprograms.  Privacy and credit laws madernit impossible for a lender to get personal information about the authorizedrnuser so FICO changedrnthe scoring model so it no longer recognized authorized user accounts in scoringrnand eliminated the automatic boost in the credit score of the piggy-backingrnconsumer. </p

FICO also changed the wayrnit treated delinquencies.  An individualrnwho was seriously delinquent – over 90 days – on a single major account whilernmaintaining his other accounts in good standing was likely to see his score increasernunder the new rules.  However, one whorndemonstrated a pattern of late payments on multiple accounts probably saw his scorerngo down.  At the time the change wasrnannounced FICO said this change could alter an individual’s credit score by 20rnto 25 points – in one direction or the other. </p

FICO scores are calculatedrnby weighting several factors from an individual’s credit report.  The credit history, which is the main focusrnof a credit report, accounts for only 35 percent of a FICO score. Given almostrnequal weight (30 percent) is the utilization of credit.  This is the percentage of credit anrnindividual has used relative to the amount that is available.  A consumer with $10,000 in open lines ofrncredit but only $2000 in debt will score higher in this category than one whornhas used $9,000 of the available credit.</p

The length of time anrnindividual has had credit counts for 15 percent of the total score.  A consumer who opened his first departmentrnstore charge account in 1985 will score higher than one who first got credit inrn2009. </p

The last two categories,rneach of which count for 10 percent of the score, are the number of times thernindividual has applied for new credit in the recent past (the 2008 changes alsornincluded a tweak to this to allow for consumer “shopping”) and therndiversity of the types of credit in a portfolio.</p

FICO has always been cageyrnabout average credit scores – occasionally publishing score ranges.  A comparison between the 2005 figures – the lastrnwe could find – and the present ranges would be informative.  In 2005, MND reported:  </p

“Approximately 1 percent ofrnthe population with established credit has credit scores below 500 and anotherrn13 percent score from 500 to 600. By far the largest group, 28 percent, is inrnthe 750 to 799 scoring range. About 11 percent of the population is in thatrnrarified area above 800 points. The median credit score (the point where 50rnpercent rank higher and 50 percent rank lower) is 723. </p

But back to the NAR’s complaint.  ThernAssociation wants FICO to either totally disregard the utilization rate for consumersrnwho had a reduction or tabulate the score as if the reduction had not takenrnplace. </p

While FICO has not publicly responded to NAR, they did conduct a studyrnlate last year on the subject of credit line reductions.  Their analysis shows that approximately 14rnpercent of the U.S. consumer credit population experienced a reduction in totalrnrevolving credit between April 2009 and October 2009.  Four percent had arnrisk trigger such as a late payment while 10 percent did not.  FICO found that among the latter group, thernaffected consumers already tended to be very low-risk with a median FICO scorernof 757 and low balances and credit utilization ratios.  As a result, small reductions in their totalrnrevolving credit lines had a minimal effect on their FICO scores.  The average reduction was $4,800; about 12rnpercent of the average revolving credit available to this population, and thernreduction resulted in average change in utilization from 24 percent to 27rnpercent between April and October 2009.</p

FICO said it observed very limited impact on scores for the no-risk triggersrngroup.  Their median FICO scores in factrnincreased slightly (from 755 to 757) during the period. 

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