FICO and NAR Debate Credit Scoring Model and Impact on Consumers

The National Association ofrnRealtors® recently called on FICO, developer of the credit scoring model ofrnthe same name, to revise some of its computations.  At issue is the alleged negative impact onrnconsumers when banks and credit card companies unilaterally reduce or cancelrncredit lines, even when consumers are in good standing on those accounts.  An NAR spokesman said that FICO’s software isrn”unable to differentiate between innocent victims and people whose behaviorrngenuinely merits reductions,” and called the FICO modelrn”archaic.”</p

Craig Watts, FICO’s PublicrnAffairs Director, told us that FICO’s scoring models are not static.  “They are constantly evolving, but eachrnchange reflects data over time, and users do not adopt new models immediatelyrnbecause of the cost and labor involved.”  Its last widely publicized change was in the springrnof 2008.  At that time FICO predicted that its newrnscoring system would help lenders reduce the default rates on consumer loansrnbetween 5 and 15 percent while actually raising the scores of somernconsumers.  </p

Utilization was not among thernareas involved in those changes.  Thernmost sweeping tweak was a response to a perfectly legal but potentially deviousrncredit repair scheme called “piggy backing.”  An account holder can name another party asrnan “authorized user” on a credit card and it has long been a strategyrnfor parents to put a child’s name on an account which automatically transferredrnthe parent’s credit history on that account to the child, giving him a leg uprnin establishing his own credit.  Wives oftenrnaccess their husband’s accounts as authorized users as well, rather than becomingrnco-borrowers or joint owners of the account.</p

However, FICO found that creditrnrepair agencies were soliciting persons with high credit scores to sponsorrntotal strangers as authorized users; in effect, paying these sponsors to rentrnout their credit rating.  The usersrngained a credit history but not the ability to actually use the card or anyrnaccess to the sponsor’s personal information. After a few months the piggyrnbacker was removed from the card and the sponsor’s credit could be rented outrnto another credit repair customer.  Therernwere stories of sponsors who made as much as $10,000 per month through suchrnprograms.  Privacy and credit laws madernit difficult for a lender to get personal information about the authorized userrnso FICO,rninitially changed its scoring model to eliminate authorized user accounts from scoring,rndoing away with the automatic boost in the credit score of the piggy-backingrnconsumer. Watts said that this change not only caused problems for honest authorizedrnusers but also for the banks so FICO subsequently made an additional proprietaryrnchange that protected scores from the dishonest users.   </p

FICO also changed the wayrnit treated delinquencies.  An individualrnwho had been penalized for a serious delinquency on a single major accountrnwhile maintaining his other accounts in good standing was likely to see his scorernincrease under the new rules.  However,rnone who demonstrated a pattern of late payments on multiple accounts probablyrnsaw his score go down.  At the time thernchange was announced FICO said this change could alter an individual’s creditrnscore by 20 to 25 points – in one direction or the other. </p

FICO scores are calculatedrnby weighting several factors from an individual’s credit report.  The payment history, which is the main focusrnof a credit report, accounts for only 35 percent of a FICO score. Given almostrnequal weight (30 percent) is the utilization of credit.  This is the percentage of credit anrnindividual has used relative to the amount that is available.  A consumer with $10,000 in open lines ofrncredit but only $2000 in debt will score higher in this category than one whornhas used $9,000 of the available credit.</p

The length of time anrnindividual has had credit counts for 15 percent of the total score.  A consumer who opened his first departmentrnstore charge account in 1985 will score higher than one who first got credit inrn2009. </p

The last two categories,rneach of which count for 10 percent of the score, is a measure of the diversityrnof the types of credit in an individual’s portfolio, and what Watts calledrn”the individuals interest in new credit.</p

But back to the NAR’s complaint.  ThernAssociation wants FICO to either totally disregard the utilization rate forrnconsumers who had a reduction or tabulate the score as if the reduction had notrntaken place. </p

Watts said that FICO had discussed the issue with NAR and pointed me to a statementrnfrom Joanne Gaskin, Fair Isaac’s director of mortgage scoring solutions as quotedrnby Ken Harney in the WashingtonrnPost.  “Gaskin, said the FICOrnmodel attaches such importance to consumers’ available credit and utilizationrnrates – they account for 30 percent of the score – because they are highlyrnaccurate predictors of future credit problems.”  Gaskin said that “‘Research conducted byrnFair Isaac last year found that consumers who utilize 70 percent of theirrnavailable credit “have a future bad rate 20 to 50 times greater thanrnconsumers with lower utilizations”. Ignoring this key indicator, the studyrnsaid, would “decrease [the score’s] predictive power.”</p

FICO also conducted a study late last year on the subject of credit linernreductions.  Their analysis shows that approximately 14rnpercent of the U.S. consumer credit population experienced a reduction in totalrnrevolving credit between April 2009 and October 2009.  Four percent had arnrisk trigger such as a late payment while 10 percent did not.  FICO found that among the latter group, thernaffected consumers already tended to be very low-risk with a median FICO scorernof 757 and low balances and credit utilization ratios.  As a result, small reductions in their totalrnrevolving credit lines had a minimal effect on their FICO scores.  The average reduction was $4,800; about 12rnpercent of the average revolving credit available to this population, and thernreduction resulted in average change in utilization from 24 percent to 27rnpercent between April and October 2009.</p

FICO said it observed very limited impact on scores for the no-risk triggersrngroup.  Their median FICO scores in factrnincreased slightly (from 755 to 757) during the period. 

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