Understanding FICO 08
Fair Isaac instituted changes to its credit scoring formula to "ensure the continued reliability and predictive powers of FICO scores." The new model, named FICO 08, made its way into the credit scoring process back in 2009. The new model replaced the existing model, which remained relatively unchanged since the 1980s.
In this article, we're going to explain how FICO scores are developed, and how they are used by the three major credit reporting bureaus. We'll also talk about the changes to the scoring formula, which were released in 2008. Finally, we'll finish up with a brief discussion outlining the controversy surrounding this new model.
Calculating FICO Scores
This topic has been covered more thoroughly in FICO Credit Scores, but it's worth a quick reminder the model calculates creditworthiness based on information in five dimensions:
- Payment History (35%): account payment information for credit cards, lenders, and retailers. Used to measure an individual's ability to pay their bills on time.
- Amounts Owed (30%): the total amount of credit outstanding relative to the maximum amount creditors are willing to extend.
- Length of Credit History (15%): the amount of time the accounts have been open with creditors and lenders.
- New Credit (10%): the number of times the individual has applied for credit in the recent past.
- Types of Credit (10%): the diversity of credit in their portfolio.
By making the calculation of FICO scores somewhat transparent to consumers, it's easier to understand how their actions can either negatively or positively affect their individual credit scores.
Changes in FICO 08
The primary reason for the switch to FICO 08 had to do with the forecasting powers of the new model. Fair Isaac believes the new model will do a better job at predicting the likelihood of default on a loan by making two changes:
- Authorized Users: a person that is permitted by another accountholder to use their account. Normally, this situation applies to a family member who is trying to manage credit for the first time, such as a college student. The new scoring model eliminates "piggybacking," which allowed individuals with bad credit to leverage the payment histories of "stronger" credit card holders by becoming an authorized user on their accounts.
- Delinquencies: the second change in the scoring model has to do with payment patterns; especially those that are greater than 90 days late. The new model is more forgiving to consumers that are in arrears in one area, but have a number of other accounts that are in good standing.
Fair Isaac predicts the above two changes will reduce the default rates on consumer debt by 5 to 15%.
Impact on Credit Scores
Many lenders use scores to determine the amount of credit to extend a borrower. These creditworthiness thresholds are usually based on pre-determined bands. To make it easier for lenders, the new scoring model will retain the same numerical range (300 to 850), minimum scoring criteria, and parameters as the prior model.
The following two examples help illustrate the rules-of-thumb that apply to FICO 08, and how this model might change individual credit scores:
- If Ann has at least one major account in delinquency, but she also has a number of accounts in good standing with creditors, then her score would likely increase / improve with the new model.
- If Lindsey has at least one major account in delinquency, and she demonstrates a poor payment pattern with several other creditors, then her credit score would likely decrease, or deteriorate, with the new model.
Examples provided by Fair Isaac indicate that consumers might experience a 20 to 25-point adjustment to their scores when the above situations apply. As emphasized elsewhere, the most effective way to improve a credit score is by ensuring the information used to generate it is accurate. This includes obtaining a copy of a credit report and looking for errors.
When first announced in June of 2007, Fair Isaac believed that lenders would start using FICO 08 as early as September 2007; when it was first made available to credit reporting agencies such as Experian, TransUnion and Equifax.
TransUnion rolled out the new scoring model in the first quarter of 2009. Equifax began using it in June 2009, while Experian started using the new model in 2011. This rollout schedule followed the settlement with VantageScore, a joint venture the three bureaus started in 2006.
VantageScore was formed to compete directly with Fair Isaac's scoring system. Fair Isaac sued the three bureaus, accusing them of unfair / anticompetitive practices which are meant to harm the FICO brand.
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