Posted by: Roby Robertson | December 23, 2007

Fair Isaac’s to change Scoring Model for Home Buyers

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The company that comes up with credit scores for millions of Americans is changing its formula — and that could affect how easily you get credit in the future.

Fair Isaac Corp., maker of the popular FICO credit score used by most lenders, says its new scoring model will better predict the likelihood of a borrower defaulting on a loan. For one thing, the new model, dubbed FICO 08, will be more forgiving of occasional slips by consumers, but will take a harder line on repeat offenders. Fair Isaac predicts its new system will help lenders reduce default rates on their consumer credit by between 5 percent and 15 percent.

The rollout of the new credit-scoring system comes at a time when lenders say they are eager for more-accurate measures of credit risk, in part because of rising loan defaults as subprime mortgages go bad and housing prices fall. And there are signs that delinquencies are creeping into other types of consumer debt, including auto loans, further prompting lenders to tighten up on credit.

The FICO score, which Fair Isaac says is used by 90 of the 100 largest banks, and other similar scores hold sway over the lives of millions of people. Financial institutions use them to determine the granting and pricing of credit. Some consumer groups have raised concerns about whether credit scores are being used properly and whether they are valid measures of credit risk for some groups of consumers, especially minorities and lower-income individuals, says Travis Plunkett, the legislative director for the Consumer Federation of America.

Credit scores, which are calculated using proprietary models, also are criticized for a lack of transparency. “This is a product, per se, but it’s a product that has inordinate influence on the financial lives of hundreds of millions of Americans,” says Plunkett. Fair Isaac, based in Minneapolis, says it believes it does a good job of explaining the factors that go into calculating the FICO score and in guiding consumers on managing scores.

Consumers could start seeing the new FICO scores by the spring, though some lenders may take additional time to test the system with their business and loan portfolios. The latest version of the FICO score will largely look and feel the same to consumers and lenders. Scores will still range from 300 to 850 — the higher the better — and the model will continue to look at the same factors, including consumers’ level of credit indebtedness and payment histories, length of credit histories, number of recent credit openings and inquiries, and the type of credit used, to determine scores.

But the new model will more finely slice and dice the information in consumers’ credit files to do a better job of separating the “good risks” from the “bad risks,” particularly for subprime borrowers; those with “thin,” or young, credit files; or consumers who are actively seeking new credit. “Those are the communities that lenders are most interested in” to determine credit risk, says Craig Watts, spokesman for Fair Isaac.

“Consumers who are low risk will score better with the new FICO version, and consumers who are high risk will score lower,” says John Ulzheimer, president of consumer education for Credit.com. Higher-risk borrowers may find it tougher to get credit, while those with less-risky profiles — though they may have gotten approved for credit accounts in the past — will start to get better deals from lenders, he says.

Two people with the same FICO score currently could see their scores diverge under the new system. One possible reason: FICO 08 gives more points to consumers who maintain a variety of credit types, such as credit cards, a mortgage and auto loan, because it shows they can manage payments on different kinds of loans. On the other hand, the new scoring system penalizes to a greater degree borrowers who use a high percentage of their available credit.

FICO 08 also will draw greater distinctions among different borrowers who are at least 90 days late in making a loan payment, known as a serious delinquency. Traditionally, many credit-scoring models grouped subprime consumers into one category. But Fair Isaac says its new model will give a higher score to a borrower in arrears if they have a number of other accounts in good standing. Conversely, a person’s score could drop if he or she has multiple delinquent accounts.

Article courtesy of Charlotte.com.

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