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5 surprising things you might not know about FICO

5 surprising things you might not know about FICO

It’s hard to read anything about the rise of online lending without touching upon the demise of the FICO score. FICO may not be the word’s most perfect credit scoring methodology, but for the most part it’s held up through multiple credit cycles. Many upstart online lenders have developed tools to compete with, or even replace, the traditional scoring mechanism, but in actuality, financial institutions are showing increasing interest in FICO scores, not less.

Here are 5 surprising things you may not know about the FICO score:

FICO usage is going up, not down: If you pick up any mainstream business press, you’ve probably read about the death of the FICO score. As part of their business plans, many online lending startups have targeted borrowers who traditionally struggled to access credit from traditional sources. Many of these potential borrowers aren’t scored by FICO because they lack credit history. Oftentimes, it’s because they’re too young to have used credit cards. So, to extend credit, many of these firms had to build their own credit models.

But when you look at the numbers, FICO is being used more, not less, in today’s market. FICO scores are used in 90% of all credit decisions, according to research firm CEB TowerGroup, amounting to 10 billion scores every year. So, even if student loan lender SoFi announced its firm was now FICO-free, FICO scores are indeed ramping. In the 3rd quarter of 2015, FICO’s Scores division saw its revenues rise 27 percent over the same period last year.

FICO does have a solution for millennials: One of the dings people have on FICO is that its credit models are backward-facing. These historical models, which first hit the market in 1989, give weight to past behavior, but pay little attention to current reality. If you paid your bills on time in the past, according to FICO, you’re likely to continuing doing so in the future. But what about a millennial who never had any bills in the past? FICO has had a hard time scoring this type of person. Instead, some fintech firms have built a millennial’s earnings trajectory into their credit models to make sure they can extend credit to the unscored.

But, FICO has developed its own scoring mechanism to deal with non-traditional borrowers. Called Fico XD and developed in tandem with LexisNexis Risk Solutions and Equifax, XD goes after previously unscorable borrowers. XD uses a mix of landline, mobile, and cable payment history and combines it with credit bureau information, if it’s available, and public and property data. According to the firm, this means 50% of previously unscorable credit applicants can now be scored. The Consumer Financial Protection Bureau reported that as of 2010, about 8.3% of adult consumers, or 19 million people, were considered “unscorable” because their credit history was inadequate. FICO claims it will include an additional 50 million people under XD’s scoring methodology.
FICO stock at an all-time high

FICO stock is at an all-time high: FICO, the company, was formally known as the Fair Isaac Corporation. It’s based in San Jose, California, and was founded by Bill Fair and Earl Isaac in 1956. While there’s been a lot of speculation about the future of FICO in light of the excitement around newer credit models, the company doesn’t seem to be feeling the heat just yet. The software company did close to $800m in revenue in 2014 and its stock trades at an all time high.

“I think some of the headlines reflect a bit of a desire by some of these alternative lenders to stir up controversy,” CEO William Lansing remarked on a recent earnings call. “We’re not really seeing it in our numbers. We’re not selling fewer Scores. In fact, we sell our Scores to many alternative lenders and those volumes are going up not down.”

There’s actually more than 1 FICO score: Though we normally think and talk about FICO scores as if there were only one score per person, the truth is that there are multiple scores on our creditworthiness. The most widely used score by all 3 credit bureaus (Equifax, TransUnion, and Experian) is FICO Score 8. Beyond that, FICO has developed multiple scoring methodologies it uses in auto lending, credit card decisioning, and mortgage lending.

FICO continues to evolve its scoring practices, which results in multiple scores. A lot has happened since the firm debuted its first score to the market in 1989. Lender credit-granting requirements, data reporting practices, consumer demand for credit, and consumer use of credit have all evolved. As the firm releases new scoring practices, lenders choose for themselves whether or not to upgrade to the newest version.

Figure 1: Dynamics of Credit Score Gaps of Lasting Spousal Relationships
Dynamics of Credit Score Gaps of Lasting Spousal Relationships

Beyond measuring creditworthiness, FICO scores also measure romantic compatibility: Maybe, instead of asking someone you meet at the bar what his or her major is, it’s a better idea to ask about their FICO score. That’s because new research has shown that big differences in credit scores could prove disastrous to a relationship. In Credit Scores and Committed Relationships, researchers for the Brookings Institution looked at data from The Federal Reserve Bank of New York Consumer Credit Panel and from credit bureau, Equifax, covering the 15-and-a-half years through the second quarter of 2014.

While the researchers didn’t exactly use FICO scores for their research, they did find that a “couples’ average level of and the match quality in credit scores, measured at the time of relationship formation, are highly predictive of subsequent separations.” Similar credit scores, if relatively high, are also predictive of lasting relationships.

In other words, couples that spend together, pay their bills together, and make sure they use proper utilization of their credit lines, stay together.

 

Photo credit: stevendepolo via Visual hunt / CC BY

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