Why Your Lender is Using an Older Credit Scoring Model

Companies that develop credit scores have a strong interest in making sure the credit scoring systems they provide to the industry are as predictive and robust as possible so that lenders will opt to select and use their credit scoring system when evaluating the potential risk of their customers. This is especially critical in today’s tight credit market where lenders are extremely cautious about extending new credit.

[Related Article: New Credit Score Could Help Millions, Eventually]

One way scoring companies accomplish this goal is by periodically redeveloping the models that generate the credit score. Generally speaking, scoring companies will update their credit scoring system every three to five years and release that new version to the market. Both FICO and VantageScore have released updated score versions in the last several years. Lenders are encouraged, but not necessarily required, to evaluate and adopt the newer version.

For comparison’s sake, think about how a software developer will periodically update and release new versions of their products and services.  The basic features and functionality of the product remain relatively the same (Windows 7 vs. Windows Vista, for example), but the new offering usually includes enhancements that improve its value. While consumers are encouraged to upgrade to the newest version, not all people do—or will do so at a later date.

The same holds true for credit scores, but it is less apparent to consumers how and when this takes place, as each lender and various entities (Fannie Mae and Freddie Mac, for example) determine whether they will transition to the updated score version. They don’t necessarily communicate what version of the credit score they are using.

An added layer of complexity comes into play now that all consumers can go out and directly request their own credit score and credit report. The version a consumer may obtain directly on his or her own may differ from other scores provided by lenders, such as the credit score version used in a lender’s risk-based pricing notification.

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Why Redevelop the Credit Scores?

Credit score developers like FICO and VantageScore frequently validate and test their credit scoring systems to ensure they effectively predict future credit risk. The scores are designed to remain robust and stable and to hold up over micro and macro-level changes. The fundamental credit behaviors that were predictive of high risk credit behavior in the past continue to be very predictive of future credit risk today. Namely—consumers who don’t pay bills on time, heavily utilize a lot of their available credit, and frequently apply for credit continue to represent high credit risk today as in the past.

At the same time, the scores need to be updated to ensure they reflect more recent consumer credit practices, accommodate new types of credit offerings and reporting practices, and can incorporate new and advanced analytic techniques the score developers have been researching and testing since the last version released to market.

For example, the first versions of the FICO scores did not factor “rate shopping logic” into the scores that consider consumers’ rate shopping trends when inquiring into auto, mortgage and student loans. The consumer-friendly rate shopping treatment logic was incorporated into later versions of the FICO score and is now considered a “standard” feature in all credit scores.

Another example: The more recent versions also reflect the fact that all consumers (high risk and low risk alike) use more credit today compared to the early 1990s. Consider that the growing use of credit cards to pay for groceries, stamps, and to make bill payments online is a relatively recent development. As such, newer score versions likely weight credit card usage patterns differently compared to previous versions.

The result of the redevelopment effort is a credit scoring system that is more predictive and more reflective of recent consumer credit and reporting dynamics—thereby providing a better score for lenders and consumers.

[Resource: Get your free personalized Credit Report Card]

Converting to the Newer Score Version »

Image: Annie Pilon, via Flickr.com

Converting to the Newer Score Version

So why don’t lenders simply switch to the newer version once it’s released?  The latest FICO version, called FICO 8, was released for lender access in 2008-2009, but not all lenders are switched over to that latest version—note, FICO recently shared that approximately 6,000 lenders are now using FICO 8.

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Some lenders do make the transition to the newer score version relatively quickly, but the majority of larger lenders want to first analyze the newer score to thoroughly understand how it will work for them. Some of the review processes include:

• Proving via their data and portfolios that the newer score effectively predicts future credit risk.
• Using measurements and quantification to ensure that the newer version is a better score (more predictive) than other credit score versions currently in use. (Why go through the effort of converting if the newer version is not more predictive on their portfolios?)
• Understanding how the newer version interacts with the other scores and analytic criteria the lender is using in their processes to review new credit requests.  This needs to be conducted for the various loan portfolios (mortgages, auto loans, credit cards, lines of credit, etc.) as well as on a bank-wide perspective.
• Ensuring all compliance and regulatory parameters related to score use are reviewed and approved.
• Making any system changes required to operationally access the score and seamlessly integrate into score use strategies.

A project this large takes time, resources and prioritization. It is important that the lender has everything lined up and ready to go when they flip the switch to the new score version. By the time some lenders have completed this work, it’s time to start again as the score vendor may be just about to release the next redeveloped version!

The score vendor and credit reporting agency partner then need to determine when they will make that most recent version available to consumers. In my opinion, it makes most sense that the version made available to consumers is the same version that the majority of lenders are pulling to make credit decisions. That way, there is a higher probability that the consumer is seeing the same score version that most lenders are seeing.

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