New Credit Score Could Help Millions, Eventually

The Basics II: OK, What’s in that Special Sauce?

To arrive at a consumer’s credit score, FICO considers a number of different factors, including how many different kinds of credit accounts a consumer has, how much of her available credit the consumer tends to use, and whether the consumer makes her payments on time.

FICO updates its scoring model every two or three years, much like Microsoft periodically releases new versions of software, Quinn says. It makes the updates partly to take advantage of new kinds of data, and also to react to changing consumer behavior.

For example, many consumers drastically reduced their credit card debt after the financial crash of 2008. In the face of such a broad behavioral change, the model must change too, since what may have been a low credit utilization rate in 2006 might have been simply average by 2009.

“Over time, degradation can occur to any scoring model,” says Clifford O’Neal, spokesman for TransUnion, one of the three national credit bureaus.

The newest version of the scoring model is more precise because it considers more types of consumers. For example, some people have little in the way of credit histories. Comparing those people to all consumers as a whole would leave them with low credit scores, even though many people with little credit history make perfectly fine credit risks. The same goes for people with unpaid bills in their past. In some cases that may mean three unpaid mortgage payments, which could mean the person is a bad credit risk now. Another person’s unpaid bills might be for small medical expenses that she never learned about.

By dividing people with similar credit histories into different groups, and comparing them against people in those groups, FICO is able to give more accurate predictions of consumers’ willingness and ability to pay.

“If you were to build just one scorecard on the whole population, people with previous delinquency would all plummet to the lowest part of the score range because compared to most other people, they look really risky,” says Quinn. “But if you build a score card based just on delinquencies, someone with lots of delinquent payments now is riskier than someone with one late payment six years ago. So it helps you find people with less risk.”

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Whereas the previous model divided consumers into 10 different categories, the new one uses 16. That should help lenders more fine-tuned decisions, according to FICO.

“With FICO 8 Score, FICO scientists were allowed for the first time to break the blueprint of our original FICO scoring algorithm,” Jason Sprenger, a FICO spokesman, told Credit.com in an emailed statement. That creates “a segmentation that rendered significantly more predictive credit scores than was possible before.”

Compared to previous versions, FICO 8 goes easier on people who have missed payments on small debts under $100, which often include medical debts. The Commonwealth Fund estimates that 14 million Americans struggle with medical debts that they believe are erroneous, the Wall Street Journal reports, and the Federal Reserve estimates that half of all debts in collection arise form medical bills.

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That means the new FICO scoring model could help millions of consumers improve their credit scores and reduce the amount of money they pay in interest.

“One of the good things in 8 is that debts under $100 are not going to have the same impact,” says Hendricks. “I think it’s safe to say a majority of those are medical debts.”

On the other hand, FICO 8 considers people with high credit utilization rates to be somewhat higher credit risks than previous versions. That may hurt the credit scores of people who use relatively high levels of their available Credit. “So if you carry high balances, you’re probably going to lose a little more points the before,” Quinn says.

The two tendencies may cancel each other out, Quinn says. Banks probably won’t become any more loose with credit under the new model, and they probably won’t lend to more people. Instead, lenders will subtly shift their definitions of which consumers qualify for which products.

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