November 18th, 2010
A New Generation of Credit Scores: Credit Undergoes A Makeover
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It’s no secret that consumer credit behavior has changed—with higher risks of default, vast unemployment, and increased rate of homeowners walking away from their mortgage—and credit scores are changing with these rocky times.
An emerging new generation of credit score models is the VantageScore 2.0 and FICO 8 Mortgage Score, revisions of the current VantageScore and FICO formulas that are modified and fine-tuned to better detect credit risk and improvement patterns.
The purpose to better identify future default, score consumers more accurately, and help lenders choose and price the right customers. Let’s take a look at the changing face of credit.
Why the changes?
Consumer creditworthiness has deteriorated since the recession hit consumers and went into full swing in 2007. According to a Los Angeles Times article, probability of serious delinquency—which is defaulting payments for 90+ days—has increased 417% among sub-prime borrowers (in the lowest credit score range) between 2007 and 2009. For other credit range of prime and near prime consumers, it is still over a 400% increase across all levels.
In addition, record levels of foreclosures and strategic defaults—which occur across the credit score spectrum from sub-prime to the credit elite—have skyrocketed in nearly every state. More and more consumers are skipping on mortgage payments in order to pay mounting credit card bills. Surprisingly, even good credit score consumers are engaging in strategic defaults.
The companies behind FICO and the VantageScore, different credit score model competitors, are making changes to the way credit scores are calculated to coincide with this change in consumers’ creditworthiness and financial behavior. In the wake of the housing bust and economic recession, these changes intend to make credit scores better reflect consumers’ real-life credit standing, and help lenders better evaluate potential borrowers.
So, what’s new with credit scores?
To cope with this change in consumer credit behavior, FICO and VantageScore are making revisions—that remain a secret, since credit score models are notoriously guarded—that hope to do the following:
- VantageScore, which is a joint venture between the three major credit score bureaus, is looking to identify emerging behavioral patterns associated with defaults. Using information from 45 million active credit files, the new VantageScore 2.0 seeks to identify subtle red flags that may indicate credit stress and growing risks of defaults.
- FICO, which offers several credit score models, is rolling out with FICO 8 Mortgage Score used specifically by mortgage lenders to analyze consumers’ credit reports for warning signs of strategic default. FICO claims the new Mortgage Score can be 15% to 25% more accurate than the standard FICO model in predicting future default.
What does this mean for you?
What kind of warning signs are these new models measuring? As usual, the specifics around credit score models remain proprietary secrets of the companies. We don’t know what exactly will be judged as a “red flag” in your credit history, but this is a good indication that lenders are tightening up lending standards and making strides to shrewdly pick out risky borrowers from good customers.
Consumers will be affected if the lender they are applying for happens to adopt and use the VantageScore 2.0 or FICO 8 Mortgage score, both slated to be out in 2011. On the plus side, you could get a better deal and lower rate if these scores work to your advantage. But if your credit history happens to be waving a few red flags, your sweet deal on your loan could end up being worse than you expected.
Credit scores aren’t the only thing that lenders are looking for and you need to watch out for; check out our recent LearnVest article for the new ways financial institutions are checking up on your creditworthiness, from your utility bills to your banking statements.