Two Sides To FICO Score Changes

FICO's recent changes to how it calculates credit scores could have consequences for your lending portfolio.

 
 

Wouldn’t it be great if credit unions could boost the overall lending portfolio without creating more undue risk?

On Thursday, Fair Issac Corp. announced changes to its FICO score calculations it will release later this year, called FICO 9. Among the changes, FICO calculations will no longer include any record of a consumer failing to pay a bill that has been paid or settled with the collection agency. Additionally, the scores will give less weight to unpaid medical bills that are with a collection agency.

As of July, and according to Experian data reported by the Wall Street Journal, approximately 64.3 million consumers in the United States had a medical collection on their credit report. 9.4 million of the 106.5 million consumers with a collection on their report will not be penalized under the new score system.

Under the current system, these collections impact credit scores as much as foreclosures and bankruptcies despite the differences in size.

What does this mean for credit unions?

There are two schools of thought. First, this good for both borrower and lender. Lenders don’t like taking undue risk. All things being equal, they’d rather make a loan to someone with a higher credit score. By altering these elements, credit scores will likely rise and along with them the pool of desirable borrowers.

Critics, including the CFPB, have said current credit scoring models put undue weight on unpaid medical debt. The new model, they argue, represents a more accurate picture of risk. And as even small shitfs in credit score can impact interest rates and application decisioning, the changes should lead to better rates and more approved loans. A win for both the borrower and lender.

The second school of thought offers a gloomier take. Loosening the definition of credit score calculation inflates the overall pool of potential borrowers and gives attractive credit scores to more individuals. Does this adequately reflect holistic risk?

It’s estimated that 75 million people in the United States had trouble paying their medical bills as of 2012. That’s up from the 58 million reported in 2005, according to a report from the Commonwealth Fund. If less weight is given to unpaid medical bills, then consumers who might already be in financial trouble can use their seemingly good credit to put themselves further into debt.

As FICO adopts the changes, credit unions would do well to take a look at their decisioning processes. Will you accept more borrowers at better rates? Will you supplement this new credit score with factors that give you a more accurate holistic view? How will you ensure a borrower’s personal finances aren’t structured in a way that will lead to losses months down the line?

 
 

Aug. 8, 2014


Comments

 
 
 
  • As a long time lender in the credit granting space, the idea of not looking hard at the small medical collections accounts was based on the fact many members did not even know they had a collection agency after them. Example, if you took a ride in an ambulance then spent a few hours in the emergency rooms, admitted into the hospital only to be sent home after 1 1/2 days and was told you look fine, you would be amazed how many doctors, nurses, specialists and others that had a piece in your recovery. After paying all of your bills, including those that are sent to your home weeks after, and after you sort through and figure what you owe and what the insurance carriers are responsible for, it is easy to miss something and now you have a $186 collection from someone you have never heard about. Let's excuse those as not being a reflection of your ability to manage your debts. But now, the Government has decided all medical debts are excused. First issue - has anyone asked the medical profession what they think about this decision. Lastly, this over site pressure to excuse all poor paying habits might someday become the end of what FICO stands for - predicting who has the means, the ability, and the willingness to take on debt and demonstrating this via a pay history scoring system reflecting positive/negative cash flow management patterns. The slight change in measuring borrower’s ability to be credit responsibility is a big deal when this amendment to FICO’s predictability may now allow some borrowers to rationalize why they are not going to pay on certain outstanding obligations which talks directly to the “willing and able” formula when granting credit. CFPB has taken a stance that alters what used to be a common sense anomaly to now suggesting borrowers are not to be held responsible for their financial obligations; My question is simply this, What’s next?
    Bill Walker
     
     
     
  • FICO adjustments are empirically derived. I would be very surprised if this adjustment wasn't vetted by FICO (undoubtedly there is a lack of correlation between a medical judgment or paid or settled collection agency debt and credit performance). Said another way, changing the weights has most likely already been proven to not change the validation odds chart in any significant manner. If that is not the case, then FICO will undoubtedly release new odds validation charts that reflect what the expected credit performance will be for any given score.
    Mike
     
     
     
  • Credit scores need to be empirically derived and validated. They are designed to predict risk. They should not be subject to the whims of a governmental agency.
    Lou
     
     
     
  • A common sense approach to medical collection accounts. Many medical providers are quick to pull the trigger on consumers sending accounts for collection, even as bills are in process of being paid. What medical providers and medical collection agencies are not quick about is reporting paid or correcting an erroneous report. Hats off to Fair Isaac Corp. for addressing the issue.
    Anonymous