Beginning this summer, the latest iteration of the ubiquitous credit scoring model known as the FICO Score will debut to either the delight or dismay of millions of consumers. That’s because the model incorporates a rejiggering of the formula for how our credit history is viewed when lenders make decisions. In the final analysis, good scores will rise a bit, while poor scores will tick lower, but the impact on most of us will be minimal.
The concept of a numerical assessment of creditworthiness began in 1956 when Bill Fair and Earl Isaac turned the power of data processing to the task of analyzing prior credit behavior in an effort to predict future repayment. Since that time, the Fair Isaac Company (FICO) has released several revisions and improvements to the FICO scoring system, which is utilized in over 90% of all consumer credit decisions in the U.S.
The newest version, known as FICO Score 10, tweaks the weighting of various aspects of an individual’s borrowing record as reported by the three major credit reporting agencies Experian, Equifax and TransUnion. One option available with the new tool is FICO 10T, which analyzes recent trends over 24 months to improve prediction accuracy. Version 10 will also weigh personal loans more heavily, so a consumer who takes a personal loan to pay down credit cards may be penalized, since the potential exists to run the balances back up.
According to the company, FICO 10 may reduce defaults by as much as 10% among new credit cards issued, 9% for auto loans and 17% of new mortgage loans compared to the current FICO Score 9. Individual lenders will decide when or if they wish to migrate to the new system.
Fair Isaac estimates that roughly 40 million borrowers with good scores (680 or higher) may see their numbers go even higher, while an equal number with “poor” FICO scores likely will experience a decline. Estimate of the magnitude of changes are in the range of 20-25 points.