New FICO scoring to lower risks for lenders

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FICO is updating its credit scoring system to rely more on debt-to-income ratio, with consumers scoring below 600 to feel the brunt of the scrutiny. The credit bureau last week rolled out its FICO Score 10 Suite, which institutions will launch by the end of the year.

The new scoring model is designed to improve underwriting and reduce risk for financial institutions. According to FICO, lenders who adopt the FICO Score 10 Suite can reduce the number of defaults in their portfolio by almost 10% with new bank cards and up to 9% with new auto loans, compared with the current system. In a statement, FICO said the new score will reduce defaults for newly originated mortgage loans by up to 17%.

Dave Shellenberger, vice president of product management at FICO, said the updates to the scoring system occur every five years and that the new model will produce increasingly accurate assessments of a consumer’s credit risk.

“It allows us to create a more powerful score,” he said. “There’s significant integrity in the data that’s being used to score the consumer; we need to ensure that we have enough data to reliably score that consumer.”

Shellenberger emphasized that the new model includes two means to calculate scores: FICO 10 and FICO 10 T. The credit bureau said it changed its model because lenders wanted a paradigm that was “backwards compatible” to encompass risk-predictive characteristics that are compatible with previous scores. Accordingly, FICO 10 T uses predictive characteristics to create a new credit score.

See also: FICO fights fraud through selfie-based authentication tools

Recent reports observed that low-income consumers could be disproportionately impacted by lower scores resulting from the new model, alleging that changes may widen the gap between customers with good credit and those with bad credit.

However, FICO stated that about 40 million consumers could experience an increase in their credit scores.

“That’s a significant improvement for many consumers; we see an equal amount will also show a decrease,” Shellenberger said.

According to a recent report, the new scoring model may reward consumers who have quickly paid off debt, but punish those who have accumulated more debt during that time.

Leslie Parrish,senior analyst at Aite Group, said the impact of the new model will depend on the consumer.

“I believe more people will be negatively impacted because [the model] is looking at overall indebtedness and is being a little bit more critical of people than the previous iteration of scores.”

Others, however, tout the benefits for financial institutions in their efforts to create reliable risk scores for borrowers.

“A new FICO version with more predictive power would be positive for consumer debt performance over the long term, and hence credit positive for consumer-related securitizations and financial institutions,” said Warren Kornfeld, senior vice president at Moody’s Investors Service, in a statement to Bank Innovation. “The impact will be muted because most lenders only partially rely on FICO scores and often are slow to adopt new versions.”

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