Need something to worry about other than the Coronavirus? How about the FICO® credit score changes that go into effect later this year.
According to most financial news outlets, consumers in credit card debt who take out personal loans to help boost their credit score may actually see the opposite happening once the new FICO credit scoring model changes take effect. In other words, rolling over credit card debt into other consumer debt won’t help; in fact, it might hurt credit scores generated by FICO.
Fair Isaac, the company behind the FICO credit score model, is pushing out a new model due to record levels of consumer debt. The FICO Score 10 Suite is slated for release as early as this summer for some companies, according to FICO’s press release.
FICO’s intent is to help lending institutions reduce the number of defaults in their portfolio. They predict the new model could reduce defaults by as much as “10 percent among newly originated bankcards and 9 percent among newly originated auto loans, compared to using FICO® Score 9,” according to their press release.
Projectors fear that more than 40 million Americans will see their FICO scores go down by 20 points.
Lending institutions understand there’s a delicate balance between lending money to any Tom, Dick, or Mary versus lending money to trusted people who will pay the loan back. They use the FICO credit score as a prognosticator of whether a person can be trusted to pay back a loan. Some institutions are willing to take higher risks if it means more people can secure lending from them. Interestingly, despite growing consumer debt, WalletHub found that delinquency rates and charge-offs are lower than they’ve been in years. What that means is people are going more into debt, but they are paying on that debt.
We’ve compiled five reason why the FICO credit score changes shouldn’t scare you. In fact, you may be able to spin it into a positive.
1. Use a different or supporting score model
You don’t have to rely strictly on the FICO credit score. FICO score is the behemoth in the market, as 90 percent of lenders rely on the FICO credit score of potential borrowers. But VantageScore, which was developed by the three national credit reporting companies (Equifax, Experian, and TransUnion), is a viable alternative. There is currently no word on if VantageScore will also adjust their scoring model based on FICO’s changes.
One of the biggest pluses to using the VantageScore model is that credit inquiries are considered to be less influential than other credit behaviors, such as payment history. And VantageScore says soft inquiries, such as pulling a credit report for account maintenance, are completely ignored in deciding a credit score. If you are dealing with potential borrowers where a point here and there could make the difference of them qualifying for a loan, it would be best to tread lightly on their credit score by only using soft inquiries into the state of their credit history.
2. Now is a great time to advertise debt pay downs
You have a few months to a year before these changes really take hold. In the meantime, it might be a good idea to offer low-interest short-term loans to borrowers to help them pay down some of their debt. According to money expert Clark Howard, the two best things borrowers can do to improve their credit score before these changes take effect are:
1. Pay bills on time.
2. Pay down their credit ratio.
A borrower with a credit line of $5,000 but only $500 expended will look better than a borrower with a $20,000 credit line but $17,000 used.
The cool thing is you can use this to your advantage. You can advertise that FICO changes are coming and opening a loan today could help their credit score in the long term. Maybe something like this:
“Need to pay down debt before the new FICO changes take effect? Ask as us how we can help.”
Then train your front-end loan officers how they can help potential borrowers pay down debt with introductory low-interest loans before the FICO score model changes.
Imagine a borrower with a credit card maxed out, but who then opens a consumer loan with your institution with regular monthly payments automatically withdrawn from their account. In six months, that borrower’s debt will be paid down, and they’ll have a timely payment record. Their score would go up, even with this new model.
Additionally, you may want to encourage first-time borrowers to start building up their credit history. That way when the changes take effect, they already have a positive history of timely payments.
3. Start tracking loan origination now to compare later
The truth is, we really don’t know how the new FICO credit scores will affect potential borrowers. It’s all speculation. If you aren’t already, you will really need to start tracking all the loans opened over a period and from where.
Keep good reports on the number of loan types being opened from month-to-month. Then as FICO changes are implemented, you can see if more or fewer loan applications are being approved. It will help you know how you should adjust your underwriting qualifications, which brings me to the next point. Further reading: Three Reasons to Check Loan Statistics Every Day
4. Decisioning Engine App
Before the Coronavirus-apocalypse, we were going to showcase one of the best web applications we’ve ever developed at our user conference, GAIN, that was scheduled for this very week. Since GAIN was canceled due to fears of spreading the Coronavirus, we weren’t able to show off our new app we call Decision Engine.
Decision Engine is already being tested in a Beta environment with a few of our institutions. The Decision Engine is a web-based service that allows institutions to set up parameters loan applicants must pass in order to qualify for loans.
What makes the Decision Engine so unique is that you and your institution can set up, change, alter, adjust, or whatever you need to approve loans based on requirements you decide. It doesn’t require help from a customer service representative, and it doesn’t require formulas.
The Decision Engine also has built-in analytic tools that can show you how many loans were approved based on set requirements, as well as how many more or fewer loans would have been approved if you dropped or adjusted specific criteria in a Decision Engine.
This can increase profitability and lead to better lending decisions as you leverage customer performance before incurring additional third-party costs in your decision tree.
We anticipate this product to be in full use around the same time as the FICO model rollout. It’s easy to use, easy to change, and probably the best thing we’ve invented since the calculator. (We didn’t invent the calculator, just the Amortization Schedules screen that calculates loans for you.) </endoftootingownhorn>
5. Don’t stress—this may actually be a very good thing
The change in the FICO scores might actually be a boon to alternative lending institutions (lending institutions other than banks and credit unions). If it’s estimated that 40 million people will take a hit to their FICO credit score, it may push them out of being eligible for loans from banks to purchase autos, household goods, or even homes.
Alternative lending institutions may see a tick up in borrower interest.
So wash your hands and be ready: this new FICO score model may make things more interesting than watching people quarrel over the last toilet paper container in the store.