FICO 08 – Understanding the “New” Credit Scores

Fair Isaac and Co. is introducing FICO 08, an improved scoring model designed to help lenders make a more accurate assessment of risk when accessing applicants. In light of increasing levels of delinquencies, as well as declining recovery values (the amount a lender is able to recover after a reposed vehicle is sold at auction), lenders have been looking for a better model to predict the likelihood of a loan default. According to Mortgage News Daily (1/7/08), Fair Isaac predicts that FICO 08 will help lenders reduce default rates on consumer loans between 5 and 15%.

The fundamental elements that FICO evaluates in computing a credit score will remain largely look and feel the same. Lenders and creditors will continue to look at:

o Payment history: Has the consumer consistently paid their accounts on time in accordance with the terms of their loan or credit arrangement?

o Amounts owed: How many accounts have balances, the amount owed on each and what proportion of available credit is being used.

o Length of credit history: Number of recently opened accounts and inquiries, the time since recent account openings and is there a re-establishment of positive credit history?

o New credit: How many recently opened credit accounts and credit inquiries are on file?

o Credit mix: How many and what types of accounts are open?

The difference with FICO 08 will be the weight each of these factors will carry. FICO 08 will more finely “slice and dice” information. According to Credit Technologies Inc. “Each scoring model is divided into scorecards, (also referred to as Population Segments.) The current FICO model uses 10 score cards. FICO 08 adds 2 more, now dividing the population into 12 segments (eight for people with good credit and four for people with bad credit.) This could result in a slight change of a consumer’s credit score either up or down ”

FICO O8 will also better identify young or thin credit files, who may now have high scores even though they have relatively few accounts, many recently opened. Consumers actively seeking new credit will be more easily identified, allowing creditors to more accurately gauge the potential risk in granting too many new accounts at once.

Another difference will be in how FICO 08 looks at credit files. A greater consideration will be given to the mix of credit a consumer has, such as a credit card or revolving account, as well as an installment loan or mortgage. This, according to Fair Isaac, shows that the consumer can manage multiple payments on different kinds of accounts. FICO 08 will place greater importance on borrowers who use a high percentage of their available credit. Accounts at or near their limits will generate a lower score for consumers.

FICO 08 will be harder on “repeat offenders”, those consumers who are consistently delinquent on their accounts, and more forgiving to those with only an occasional slip up. While delinquent accounts have always had a negative impact on a FICO Score, consumers who have a number of accounts currently past due will generate a even lower score than they currently have. A consumer with only one derogatory or delinquent account won’t be dinged as hard, and in fact, a consumer in arrears in one account who also has a number of accounts in good standing may generate a higher score under the new system. However, FICO 08 will draw a greater distinction for serious delinquencies over 90 days late. Multiple delinquent accounts could significantly lower a consumer’s score. According to the Better Business Bureau (BBB), the new scoring method is more forgiving of minor slip-ups.

A very significant change coming is that FICO 08 will no longer consider “authorized users” in computing a credit score. This is in response to curtail the use of “piggybacking” or “credit sharing”, where a creditor with a low score is added to an account of a non-related consumer in an effort to boost the first consumer’s score. If a consumer’s only credit history includes authorized use accounts they could see their credit score disappear!

Consumers who are considered a “lower” risk under FICO 08 may start to get better terms from creditors. A consumer deemed to be a “higher” risk under the new scoring system may find less than favorable terms, or may find it tougher to even get credit. Consumers who occasionally mess up, have a good mix of credit types, with a single delinquent account may actually see their credit scores rise. Consumers who consistently mess up, have balances at or near their credit limits, are 90 days late on multiple accounts or have authorized user accounts in their file, may see their credit scores drop. Additionally, FICO 08 will not “ding” a credit score for multiple related credit inquiries. A consumer shopping for a mortgage or an auto loan who applies to multiple lenders will not see their score drop because of the inquiries.

So, when will FICO 08 come into play? Experian is expected to begin using the FICO 08 in the first quarter of 2008, while TransUnion believes they will be ready by the second quarter of 2008. At this time, Equifax has declined to offer FICO 08 due to litigation regarding “VantageScore”, which is a joint venture, started by all three bureaus in 2006, to compete with Fair Isaac’s FICO scoring system. The lawsuit, filed by Fair Isaac, is based on unfair and anti-competitive practices which are meant to harm the FICO brand. The legal action has caused Equifax’s relationship with Fair Isaac to remain “strained” until the lawsuit is resolved, says David Rubinger, Equifax spokesman, as quoted in the December 19th, 2007 edition of the Wall Street Journal,

When FICO 08 is implemented, many consumers will not see a significant difference in their scores. According to Tom Quinn, Vice President of Global Scoring Solutions for Fair Isaac, as quoted in the December 19th, 2007 edition of the Wall Street Journal, “Overall, more consumers will see their FICO scores go up slightly than will see their scores drop.”

Exactly what the future holds is unclear whether FICO 08 will affect the buying patterns of your lenders remains to be seen. One thing for certain is the publicity surrounding FICO 08 may raise the anxiety level of your customer. Being able to effective communicate what they can expect will go a long way in easing their anxiety. If change is indeed inevitable, it’s best to be ready for it!

Geoff Cohen is a seasoned auto professional, with over 30 year’s experience. He has done it all, from sales rep to F&I Manager, New Car Manager, Used Vehicle Manager, up to GSM and GM. He has also worked as an area sales manager for a major sub-prime lender as well as run his own BHPH and Auto Leasing/Brokerage Company. He is currently the Dean and Faculty Chairman of the Academy of Special Finance. Geoff is a contributor to several auto industry publications including F&I Magazine and World of Special Finance Magazine, as well as being a guest speaker to many dealer groups around the country. He coaches auto dealerships on improving their Special Finance departments, and is the National Accounts Manager for AutoLending Network, helping dealers take Subprime sales and profits to the next level!