After years of focusing nearly entirely on a consumer’s payment history, FICO has announced that as of 2019 it will be rolling out a new scoring system that will take money management into account in ranking borrowers. Specifically, FICO scores will now take a peek into how consumers manage checking, savings and money-market accounts — and use that data to make determinations on a borrower’s worthiness.
The change is reportedly one of the largest shifts in both the FICO scoring system, and credit reporting in general, in the last 30 years.
The retooled system will be called the UltraFICO. It is intended to be more inclusive, according to reports, and to make it easier for consumers to qualify for mainstream financial products like credit cards or mortgages by taking into account their past history of cash transactions.
The moves cones as a response to the frequent “Catch 22” scenario that FICO scoring is accused of creating: a consumer cannot gain access to credit without a solid history of paying back loans, but can’t build said solid history of payment if no one will underwrite them because of their lack of credit history.
Those shortcomings have led many to wonder if the FICO score — after over a half century in use — is actually keeping pace with modern financial services. It’s a question Experian sought to answer with the first-ever State of Alternative Credit Data report earlier this year. And the answers weren't entirely favorable for FICO. Despite being the dominant deciding factor in most consumer lending decisions for the last 30 years, Experian’s report indicated that FICO as it is configured today is only working well for about half of American consumers. Meanwhile, for the other half, the model has a hard time getting a full enough picture when it comes to capturing financial activity of lots of consumers in the present.
“What we’ve seen is that when additional fields of data become visible to a lender, suddenly a much more comprehensive consumer profile is formed. In some instances, this helps them offer consumers new credit opportunities, and in other cases it might illuminate risk,” noted Paul DeSaulniers, Experian’s senior director of Risk Scoring and Trended/Alternative Data and Attributes.
And FICO’s dominance is under threat. As of early 2018, the Federal Housing Finance Agency (FHFA) — the federal body that stands behind the guarantors of most American mortgages, Fannie Mae and Freddie Mac — had begun considering opening up the market for credit assessment beyond the FICO for mortgages it approves.
The pressure, in short, has been on FICO all year to modernize its approach, and to build a more inclusive comprehensive system.
That pressure has continued to mount as strong economic conditions have served to make consumers putatively more credit-worthy — and pushed underwriters to want to bring additional consumers into the credit markets. Unemployment is at record lows and wages are gradually pushing up. Loan balances among borrowers, however, are at an all-time high — and according to The Wall Street Journal, lenders are looking for ways to keep expanding loan volume.
The UltraFICO is meant to be an adjustment to the system that will make that kind of expanded underwriting theoretically possible, by offering a boost to consumers who might otherwise be too thinly-filed to properly evaluate. The system, in theory, would allow customers with a sub-prime regular FICO score to have their score recalculated to reflect banking activity. Consumers who keep a few hundred dollars in their account, transact often and avoid overdrawing will particularly see a benefit to their score.
Applicants will be able to choose which accounts they want considered when the score is recalculated.
And, according to FICO, there has already been strong interest in applying to the new model; Pentagon Federal Credit Union, the third-largest U.S. credit union by assets, is reportedly one such lender.
David Shellenberger, FICO’s senior director of scoring and predictive analytics, said the new score is designed to both keep risky borrowers from appearing more creditworthy than they are, and qualify borrowers whose positive financial behavior was previously invisible. Some borrowers, he noted, will actually see their scores decrease when the new information is taken into account.
Experian, reportedly, will compile consumers’ banking information with help from FinTech firm Finicity and will distribute the new score to lenders. The credit-reporting firm also will send lenders a report that includes a summary of the consumer’s bank accounts. Consumers with an average balance of at least $400 and no overdraws within three months will see a boost, according to FICO.
FICO says it anticipates that about seven million applicants who have low credit scores as a result of thin borrowing histories will see an improvement under the new system, while some 26 million subprime borrowers will end up with higher credit scores. About four million, they anticipate, will see a jump of at least 20 points.
And while underwriters' enthusiasm to lend more in the current favorable economic conditions, and the push for more accessible and affordable forms of credit for a wider range of borrowers has been a rallying cry in the financial services ecosystem since the Great Recession and the attendant credit crunch, one might pause to wonder if perhaps more credit is really what Americans need. As Karen Webster pointed out in a recent commentary, household finances actually don’t look nearly as strong under the hood as they do on the surface. She noted, “Despite these seemingly sound, strong financial fundamentals, more than a third of consumers report falling behind on bills, up 6 percent from this time last year, in an economy that is booming with inflation rates below 2 percent for more than eight years.”
And lenders aren’t universally looking to bulk up those lending numbers. Goldman Sachs is pulling back its lending unit Marcus — despite its popularity and strength in attracting consumers.
According to the sources, the change in 2019 plans is due to current market conditions for consumer lending and could change. Some lenders are worried about the chance for increased losses in consumer credit as interest rates rise. In addition, total household debtfor the U.S. hit $13.15 trillion in the fourth quarter ending in December, which is a $193 billion increase from the third quarter.
There is a lot of debt out there, and some are wondering if the goal really is to add more borrowers to the pile.
FICO, for its part, remains confident in its plans, and says it is “very focused” on its “ability to separate future good borrowers from bad borrowers,” according to Shellenberger.
To see how well the system works — and whether it fends off the various FinTech challengers to FICO’s crown — we will have to wait for 2019.