The question is not just if credit scores will change, but how much will they change, and in what situations are these fluctuations actually meaningful to lenders?
For lenders specifically, the dynamic nature of consumer credit scores presents two very unique issues.
First, it’s pretty much a given that some consumers approved for loans based on credit scores that met or exceeded the lender’s minimum requirement, or cut-off, will see their scores fall below the cut-off at some point afterward. Alternatively, other consumers are declined loans because their scores fall below the lender’s cut-off now, but they may improve their scores, and creditworthiness, in the short term.
How should lenders view consumers whose scores might fluctuate in this this fashion — and how do they fit into sound lending strategies?
VantageScore has a point of view which it expresses in its latest white paper. In it, VantageScore analyzes the movement of credit scores among 2 million randomly selected consumers to better understand the relationship between volatile credit scores and credit risk.
Not surprisingly, consumers who maintain more stable credit management practices exhibit greater stability in their credit-score migration, whereas those with more erratic practices usually end up with greater credit-score volatility. That generalization doesn’t really help lenders with their approval decision-making, however.
What VantageScore found by analyzing consumers’ credit scores during a two-year period between 2011 and 2013, is that when variations were within a 40 band, those fluctuations were typically the result of low-risk, day-to-day credit management actions. Essentially, those are the types of behaviors that don’t necessarily reflect a substantial increase in risk exposure to lenders.
For instance, for the 65 percent of consumers who initially passed a 620 credit sore cut-off, only 3 percent of those consumers failed to meet the cut-off three months later when they were re-scored. At the 12-month mark, the percentage of consumers in the initial group who failed to meet the 620 credit score cut-off increased to just 6 percent.
The results show that credit strategies can be enhanced by simply focusing on quarterly or monthly score trends for credit approval, rather than traditional, single point-in-time credit score cut-offs. These practices can also help to improve the overall selection of potential borrowers.
When tracking overall changes in the credit scores of consumers over a three-month period, VantageScore’s study revealed that 49 percent of consumers had an average credit score improvement of 19 points. Nearly 30 percent of consumers showed an average score increase of 24 points during this same timeframe, while the remaining 21 percent had credit scores that remained at the same level over a three-month period.
A very similar pattern was seen when monitoring credit score migration across a 12-month period. Just 11 percent of consumers showed no change in their credit scores, while 51 percent experienced a jump in their scores averaging 21 points, and 38 percent showed an average increase of 34 points.
VantageScore’s study challenges the conventional thinking that a consumer’s access to credit is dependent upon their credit score at a particular point in time. They observed that when the overall credit score migration was above and below the imposed cut-off, reviewing a consumers’ score three months later showed that 6.4 percent of the total population would have received an different credit decision.
What’s also important to lenders is to clearly distinguish what constitutes a “meaningful” credit score change in the first place.
To do this, VantageScore suggests combining insights from two components of credit score model design: how a credit score varies with the risk (or odds) of a consumer defaulting, and classifying the behaviors a consumer uses to manage their credit as low or high risk to gauge typical impacts to their score.
“With the understanding that a credit score is simply a proxy for risk, the fact that a consumer’s credit score changes or doesn’t change is only meaningful in the context of understanding the actual risk estimate associated with the credit score at any given point in time,” the white paper states.
While there may not be a crystal ball that can tell lenders how creditworthy a consumer approved today will be tomorrow, the insights from the study underpin the significance of factoring in the current improvement in economic conditions, as well as using alternatives to a single point-in-time score cut-off. Both of which may help lead lenders down a path of not only relaxing their credit standards to a certain degree, but also expanding the number of creditworthy consumers being considered.