Credit Score Factors in Flux

By Daniel Duffield

While credit reports have been employed for quite some time, the idea of the credit score is relatively new. With the various factors used to determine credit score, a numerical representation of a borrower’s risk can be calculated as an indication to lenders of reliability or of a lack thereof. Although most people would be familiar with this scoring procedure, many do not fully understand the underlying process or factors which contribute to a credit score.

Within the past several years, FICO, the leading organization in credit scoring technology, has worked with several other providers in order to provide borrowers with an education of credit fundamentals, such as the considerations which influence credit score and the methods of credit improvement. This education has developed further into online simulators which allow consumers to assess their credit under a variety of circumstances.

However, this transparency has created some issues and caused some concern that the process might be used for manipulative purposes. For instance, consumers have the ability to test the effects of paying off certain types of debt, as well as to compare the effects of various actions such as opening new lines of credit. According to Gordon Crawford, recently promoted vice president of Analytics for Dataquick, believes this phenomenon to be both advantageous and disadvantageous. With this access to the reasoning behind credit scores, consumers have been given more opportunity to attempt to “game” the system, and credit scoring companies have been forced to take this phenomenon into consideration when adjusting their credit scoring models. While Crawford endorses the idea that consumers should understand their credit scores and the ways which it can be raised, he also cautions that the potential for manipulation could undercut the validity of the scorer’s model.

As such, credit scoring cannot remain static and must fluctuate in order to lessen the potential for consumer misuse. However, credit scoring constantly shifts in accordance with the mortgage market, and the definition of acceptable credit scores has varied widely over the last decade. From 2002-2008, a FICO score of 700 would be considered adequate, although this decreased steadily to 660 and even down to 580, which is currently viewed as a bad credit score. In 2008, this trend reversed, with credit scores of 760 to 780 being considered only average. Currently, circumstances of the mortgage market are unique, as mortgage rates continue to decrease, hitting record lows, while credit requirements are tighter than ever. According to Crawford, current credit trends have been too strict, with lender expectations much too high.

Furthermore, credit considerations fluctuate from a lender standpoint. Crawford stated that the mortgage industry has been confronted with the problem of numerous vendors updating their scoring models in a system that is struggling to keep up. When it comes to credit scoring, everything essentially springs from the FICO model, with small tweaks being made when necessary. In addition, existing pricing models and underwriting standards rely on pre-existing systems for scoring, making replacement both costly and difficult. As a result, lenders would like to see noticeable changes to the structure of the system as well as quantitative benefits before assuming more risk and expense in order to train people to accommodate a new system.

One recent example comes from FICO’s release of a new credit scoring model which utilizes data from CoreLogic credit reports when assessing a borrower’s score, consequently putting more emphasis on information including property transaction data, landlord/tenant data, borrower-specific public data, and other alternative credit data. FICO has asserted that the newly updated model increases borrower scores, generally raising scores to allow approximately 3% more individuals to achieve scores greater than the latest median of 715,  and better assesses borrower risk by a factor of 7.5.

Speaking of these new updates, Crawford stated that these measures will provide more consideration for borrowers with slim criteria for risk evaluation. However, the formation of a new standard can be detrimental to a lender who could potentially risk losing common measures, being unable to transfer, service, or sell the loan due to the differing credit standards.

 According to Crawford, lenders are content with the current status quo of stringent underwriting practices. The proposed changes could increase uncertainty in the mortgage market and create various problems. As such, lenders will not expose themselves to additional risks without compensation or the promise of more comfortable circumstances.

However, lenders utilize a variety of factors aside from credit scoring when determining borrower approval and assessing borrower risk, such as appraisals, owner occupancy status, etc. Essentially, credit scores aim more to predict success with a loan, not specifically aiming at mortgage loans. Consequently, many lenders increase the weight of credit scores by including these considerations within the underwriting.

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