The Fall Of FICO Standard

Having worked in the mortgage field for a few decades, the scoring of FICO (or disgust of it) definitely caught my attention.  Some of the credit-scoring travesties are given.  In my opinion, they can't make changes fast enough......or merely admit you're only going to lend to the rich.  That's what it's coming down to; slowly but surely.

Naturally, lenders of all stripes have been evaluating credit for far longer than FICO (originally founded in the ’50s as Fair Isaac Co.) has existed. In fact credit rating standardization wasn’t a priority until the 1970s with the passage of the Fair Credit Reporting Act — and FICO data has only been widely available to lenders since 1987. The FICO scoring system (the 300-800) as we sort of understand it today has only existed since 1989 and it  wasn’t until 2003 that consumers had legal access to it.   

The question now, it seems, is are the days of the FICO score as the be-all, end-all consumer credit scoring standard coming to an end? Driven by alternative lending players who’ve moved beyond FICO and developed their own lending criteria based on proprietary algorithms, a consensus is emerging that the backward-looking FICO measurement system could perhaps stand a digital age makeover with models that are based more closely on the real-time data consumers are producing, as opposed to historical data about their spending and debt management.

One reason, as many have pointed out, is that those backward-looking methods tend to rather heavily penalize consumers whose credit history is merely “thin” or short. Currently, there are a little under 30 million Americans who are “credit invisible” — meaning about 11 percent of the adult population lack a developed credit file. Another 8 percent have some credit history, but not enough of one to generate a score, according to the CFPB.

Moreover, consumers can easily fall into what is called the credit Catch-22, where the consumer can’t gain access to credit due to lack of history (or a somewhat spotty past) — and can’t build that track record of good credit management, because no one will offer them credit to manage.  

But the alternative systems are predicated on the idea that there is in fact a good deal more of information about a consumer’s likely repayment path than data reported by banks and credit card companies to the major credit bureaus. One lender PYMNTS interviewed last week noted that FICO is becoming a less and less useful tool for many lenders and consumers.

“FICO-based underwriting doesn’t do a very good job of answering two questions: ‘Can you pay us back, and if you can, will you pay us back?’ And that’s what we’re really good at seeing, because we look at thousands of small data clues that give us the answer,” Doug Merrill, CEO and Founder of ZestFinance (and former CIO of Google) told PYMNTS in a recent interview.  

For a quick example, Merrill noted that Zest looks at customers with prepaid phones and how often they change phone numbers. Since customers “lose” their number by not reloading the phone promptly, a customer who changes their number a lot represents a much greater credit risk than one who has had the same number for a while — even if they have the same FICO score. One, he noted is a major red flag. The other is a sign you are dealing with someone who is serious about keeping their bills paid.

And as alt players like Zest (and VantageScore, and Kredditech, just to name a few) are gaining more and more traction with their alternative rating platforms, it seems even the most mainstream players are starting to come around.

Take, for example, TransUnion — one of the big three credit rating agencies. The agency is in the process of rolling out its own credit ranking system to capture consumers whose files are either too thin to evaluate the old way — or who are perhaps underscored via the traditional method.  

The new system is called CreditVision Link, and last week TransUnion noted that it is designed to paint a more detailed and nuanced creditworthiness profile — and offer a creditworthiness snapshot for those who are normally overlooked by traditional rankings. According to Mike Mondelli, the SVP of TransUnion’s Alternative Data Services, CreditVision Link is designed to assign a meaningful score to 95 percent of American consumers.

The score is generated, according to TransUnion, to take a closer look at a consumer’s traditional history supplemented by data not accounted for before. For example, while regular scoring includes whether you make required minimum balance payments on time, CreditVision Link focuses on the actual size of the payment and whether it is going down.

CreditVision Link further scans data not currently counted into the system, like how often the customer’s address changes (as it could indicate they are a problem tenant with timely payment issues) data from payday loans (which are not currently reported to the credit rating agencies) and checking account history (specifically if one has a history of writing rubber checks and getting their accounts shut down over them).

It should be noted, TransUnion’s Mondelli said, that more data does not always mean a higher score for the consumer. In fact, it could mean just the opposite (as things that were hidden before are now laid bare).  

However, Mondelli noted, by and large it helps. A recent auto-lending pilot using the new metrics saw an uptick in underwriting of 24 percent.

And TransUnion is not the only traditional player jumping into the wild world of alternative ranking systems. Even the classicists over at FICO are getting in on the act, so to speak, as it has developed its own new score (in conjunction with Equifax) which provides data on cellphone and cable accounts and LexisNexis Risk Solutions, which provides property records and other public data.  

They are calling it FICO XD. So far in testing, it has allowed more than half of all applicants who had been previously unable to get a score actually have one to call their own.

“It’s definitely an on-ramp,” said Jim Wehmann, EVP For Scores at FICO.

Or at least it can be. Chi Chi Wu, a lawyer with the National Consumer Law Center, noted that there is a risk, because these systems are under development and some consumers could be hurt depending on how information is gathered and leveraged as part of the new processes.

“With alternative scoring, the devil is in the details,” she said. “It really depends on the type of alternative data and how it’s being used.”

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