Looking At Creditworthiness, Backwards And Forwards

Credit scoring as a predictor of credit risk is a challenging proposition. After all, the rearview mirror approach is at work here, with past behavior being used to project future creditworthiness.

To that end, a recent white paper by VantageScore seeks to help provide a roadmap on how today’s borrowers may – or may not – be good credit risks tomorrow.

In an interview with PYMNTS, VantageScore SVP of Research, Product Management and Analytics, Sarah Davies, noted that credit scores change all the time, and that it’s crucial for card issuers and other lenders to be cognizant of what drives those swings.

“The idea behind credit scores, said Davies, “is that every time a consumer transacts with their credit card or makes payments on a mortgage or car loan, that possibly has an impact on credit scores. We know that when you make an on-time payment your score improves, while when you run up the utilization on your credit card your score goes down,” she added.

For lenders, said Davies, a question that must be answered is “do you have the capacity to understand” if those swings mean that borrowers are actually signifying that they are higher risk? “How would you lend – if you knew that those scores were going to deteriorate?”

The answer may be a bit murkier than what lender experience or historical trends suggest. Davies stated that rules of thumb that may have governed past lending criteria might not hold hard and fast nowadays. Credit scores, she told PYMNTS, can see outsized swings on the utilization of credit. The fact remains that lenders must have what Davies termed “longitudinal awareness” and with attention on how credit use can move scores positively or negatively.

It is the up or down that has to be put in perspective. The study conducted by VantageScore found that, given credit practices at an individual level over a 90-day period, nearly 50 percent of the 2 million individuals whose credit files were studied showed credit score swings in which their scores improved by 19 points, while conversely, 30 percent saw their scores slide by, roughly, 24 points. Those 2 million consumers were randomly selected from the Experian consumer credit database, with credit scores tallied every quarter from 2011 through 2013.

Davies cautioned that swings of about 20 points, one way or another, “may not necessarily be significant,” and need not “raise red flags” among lenders – and yet attention must be paid when those tallies come in at 40 point (or more) swings up or down. When evaluating risk using the VantageScore 3.0 model, a 40-point reduction in score indicates a doubling of the odds of default; conversely, a 40-point score improvement halves the odds of default.

The study also looked at score migration over a longer 12-month timeframe, for consumers in several credit-risk groupings, as measured using the VantageScore 3.0 model. Among consumers with credit scores in the range of 601 to 700, for instance, 12 percent showed no change in score, 54 percent showed score improvements and 34 percent experienced credit score decreases.

To learn more download VantageScore’s whitepaper “Consumer Credit Score Migration” here.