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The New Credit Scores That Could Get You a Loan
Legislation introduced late last year aimed at changing the way the nation's largest mortgage loan holders, Fannie Mae and Freddie Mac, conduct business, could signal a tipping point in how, and even if, credit scores are calculated for lending decisions.
In December, U.S. Reps. Edward Royce (R-Calif.) and Terri Sewell (D-Ala.) introduced the Credit Score Competition Act of 2015 (HR 4211), addressing the "credit score monopoly" at Fannie Mae and Freddie Mac, which are currently relying solely on a FICO credit score model to determine which loans to back.
"The GSEs' [government-sponsored enterprise] use of a single credit score is an unfair practice that stifles competition and innovation in credit scoring," Royce said in a statement. "Breaking up the credit score monopoly at Fannie and Freddie will also assist them in managing their credit risk and decreases the potential for another taxpayer bailout."
The Rise of 'Alternative' Credit Scoring
Experts in the credit scoring industry have talked about the value of alternatives to FICO for years. The practice considers things like rent payments and utility bills when looking at creditworthiness, ultimately giving more people access to credit.
In fact, some lenders already are choosing to use alternative credit scores — or ditching credit scores all together. It could make a big difference for millions of Americans with non-existent or "thin" traditional credit files who have limited access to financial tools.
Fair Isaac, the originator of the FICO model, saw the writing on the wall as other credit scoring companies entered the market and launched a pilot program in April 2015 looking at alternative credit data.
"The FICO XD pilot program represents tremendous progress in expanding access to credit to more individuals," Dave Shellenberger, senior director of scoring and predictive analytics at Fair Isaac, said in an email. "Using alternative data, we can score more than 50% of the millions of 'credit invisibles' who apply for credit.
"In our pilot program, we have found that over 1/3 of these newly scored consumers have scores over 620, which is a common threshold for lenders. Most 'credit invisible' people with FICO Score XD scores above 620 who open traditional credit accounts go on to achieve high standard FICO Scores."
Consumers Could Benefit
There are dozens of credit scores used by financial institutions to judge our creditworthiness. FICO alone offers more than 50 different FICO scores to financial institutions and in some cases, directly to consumers. In addition to FICO, VantageScore offers credit scores, each of the three major credit bureaus — Experian, Equifax and TransUnion — offer their own credit scores, and a number of other companies have credit scores, too. There are also a number of "educational" credit scores that are intended for regular people to use to get a better sense of their creditworthiness.
A survey commissioned by VantageScore Solutions in November found that U.S. consumers want to see a shift in the credit scoring industry. (Credit.com offers VantageScore 3.0 as part of its free Credit Report Card.)
The phone survey, of a representative sampling of more than 1,000 consumers, showed that the majority support newer methods of calculating credit scores and that most Americans also support competition among developers of credit scoring models. Survey respondents expressed approval for multiple features of modern credit scoring models, including recognition of positive payment histories for rent, utility and telecomm bills.
The survey found:
A plurality of the national population (49%) and a slight majority of millennials (51%) believe that rent payments should be factored into credit scores, rather than consigned to separate specialty scoring models (38% and 40% respectively).
Across the board, consumers take a positive view toward having multiple credit scores, from different models. In fact, only 4% of U.S. consumers who have been scored by more than one credit scoring model viewed having multiple scores negatively, while over 55% characterized the trend as positive.
The survey also explored the extent to which consumers may be positively impacted by credit scoring models that exclude paid third-party collection accounts. Approximately 5% of Americans report having a paid-off collection account (an estimated 12 million), which are excluded from consideration in VantageScore 3.0, VantageScore Solutions' latest credit scoring model.
Other Lenders Heed the 'Alt' Call
One company that has embraced credit scoring alternatives is online lender SoFi, which made its name in the student-loan refinancing space. Following a successful pilot program that began in the fall of 2015, SoFi said it would no longer factor FICO scores into its loan qualification process. Instead, the company considers three criteria — employment history, track record of meeting financial obligations and monthly cash flow minus expenses — to determine if an applicant is qualified for its loan products.
"Our approach to underwriting is based on transparency and balancing the needs of our members and investors, and we found that the FICO score was anything but transparent. So we threw it out," CEO and co-founder Mike Cagney said in a statement. "Instead of relying on a three-digit number to tell us who's qualified, we look for applicants who have historically paid their bills on time and make more money than they spend. It's that simple."
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