Fair Isaac Corp. is changing the FICO score calculation, and many consumers will have higher credit scores as a result. The FICO score is still the most widely used measure of a consumer’s creditworthiness. The current calculation is called “FICO 08” and the new calculation to be rolled out soon is called “FICO Score 9.”
Banks rely on credit scores like the FICO score to determine whether to lend money to consumers and how much to charge borrowers for that privilege. Overall, the higher credit score you have, the lower loan interest rate you may qualify for. FICO isn’t the only game in town. Lately, it’s been seeing some competition from products like VantageScore. VantageScore recently updated their own scoring algorithm to better reflect risk, and because this score is backed by the three credit reporting bureaus, Experian, Equifax, and TransUnion, it has been gaining traction among banks and lenders.
The update to FICO is Fair Isaac’s response to the new VantageScore algorithm. FICO’s new scoring approach, FICO Score 9, prevents certain behaviors from negatively affecting scores.
Accounts that have been transferred to collections agencies and have been repaid are dropped, so these accounts are no longer factored in. Previously, an account that had been in collections but has been repaid remained a negative factor in calculating a FICO score.
Medical debt won’t negatively affect your credit score as much. FICO now believes that medical debt has little to do with creditworthiness and risk. Most people find themselves in medical debt not because they are bad at handling loans, but because they were ill-prepared for a major medical expense. Sometimes, even the best emergency funds can’t handle immediate medical expenses.
Yet, presence of medical debt can certainly be a problem when a person is considering taking on more debt, which is why a bank would look at a credit score.
These changes, plus an alleged new technique for diving the creditworthiness from consumers without a credit history, are purported to be good for consumers in general. And for those who fall into the above categories, scores will undoubtedly increase. Increases scores, in theory, have great advantages for consumers. Debt becomes less expensive. If you qualify for a better mortgage rate by 50 basis points (or 0.5 percentage points), you could save tens of thousands of dollars over the life of the mortgage. This is significant savings and could be a fantastic benefit. It could help more people reach financial independence or debt-free living sooner — or at all.
This is a very optimistic outlook. Maybe Fair Isaac has consumers in mind — and considering part of the impetus for these changes were recommendations from the Consumer Financial Protection Bureau, there is definitely a pull in favor of a large portion of Americans, those who borrow money sometime in their lives. But Fair Isaac doesn’t deal directly with consumers for the most part; banks do. And banks have a way of turning anything good for consumers against the consumers.
New regulations to protect consumers? Banks charge additional fees. Lower rates available on mortgages? Fewer consumers qualify for credit. Extremely low rates for banks borrowing from the Federal Reserve? Extremely low interest on savings accounts. New, higher credit scores for a portion of American borrowers? The potential results seem clear: Higher loan interest rates, a higher standard for lending, fewer loans, or a combination.
Does a bank look at raw credit scores or percentiles? From a financial perspective — and these are companies in the financial industry so they know all about evaluations from a financial perspective — it doesn’t make much sense to evaluate loan applicants on raw numbers. Percentiles hold the keys to decision-making.
Let’s saw a university based its applicant acceptance solely on SAT scores. The SAT scores its test on a scale up to 800. When I was in high school, there were two SAT tests, math and verbal, for a total possible score of 1600. A score of 650 out of 800 in math would have been very good, and would have qualified the test taker for a good percentage of universities. That score might have been in the 90th percentile, so scoring a 650 in math means you’ve performed better than 90 percent of the population.
The SAT company changes the test, though, and in one year, perhaps they made the test easier. The same person who received a 650 might now receive a 680. That sounds like an improvement, but because the test has changed, now that 680 is the lowest score necessary to be in the 90th percentile. Your score improved but so did everybody else’s. Colleges aren’t just going to admit more students because more test-takers scored 650 or above, they’re going to move the cut-off to remain with the 90th percentile.
And that’s how I expect things will work with credit scores as well. There’s some leeway because the scoring change does not result in an across-the-board credit score increase. Only a portion of consumers will benefit from increased scores. But even though increased scores are limited to people who fall into those categories, the percentiles will change. Some people will probably see a benefit in the form of lower loan rates or a higher potential for qualification, but it won’t affect the overall amount banks are lending. The pool of money ready for loans won’t get bigger, at least not due to this change. If banks loan more money next year than this year, that would have happened regardless of Fair Isaac’s meddling.
With the new score calculation, there doesn’t appear to be a way for any consumer to see a lower credit score. Of course, some consumers will see lower credit scores over time, but that would be a result of their particular behavior with credit rather than the scoring algorithm change.
Some people win, some people will lose. And the people who lose will be those who weren’t affected by the score change, in other words, those who don’t have medical debt or haven’t had collections.
Another factor to keep in mind is that interest rates are still historically low. Experts have been predicting the rates would increase ever since the Federal Reserve Board began lowering them. Eventually those experts will be correct. Interest rates could go up at the same time more people have higher credit scores.
You can’t see your own FICO Score 9 yet. You can find out your FICO scores under the previous version of the algorithm by visiting MyFico.com and ordering “FICO Standard” products for each of the three credit bureaus. Because each of the three bureaus could contain slightly different data about a consumer, there could be a different FICO score for each bureau, even under the same FICO 08 calculation.
With the introduction of FICO Score 9 to lenders, consumers don’t yet have the ability to see exactly what lenders who use FICO Score 9 see. That puts consumers at a disadvantage yet again, just as when FICO Scores were not available to the public, and you were never able to know your own credit score until you applied for a loan. I expect Fair Isaac will begin allowing consumers to buy their scores using the FICO Score 9 algorithm eventually, but not before the lenders get a glimpse of the overall data and can make new decisions.
I decided to order my FICO 08 scores from all the bureaus. Previously, I had only monitored my score for free using CreditKarma, and the score reported there, my “TransUnion New Account Score,” has remained 790 for a long time. CreditKarma also reports a VantageScore of 874 for me, down from 886 a few months ago. MyFico charges $19.95 for each score, but I found a discount code (S1403STL20FST) to reduce that price.
Within seconds, I received my FICO 08 scores from each bureau: 807 from Experian, 806 from Equifax, and 806 from TransUnion. I expect little change between FICO 08 and FICO Score 9 for me since I don’t fit any of the above categories. But, if I had medical debt, my score could potentially increase by 25 points.
What do you think about these changes to the FICO scoring algorithm? Will it have a positive effect for consumers? What are your credit scores? (You can share them anonymously if you like.)