FICO Scoring System Update: Low-Income Customers May Face Reduction In Credit Scores

• FICO has announced the updates it would bring into its scoring system.
• The updated system would place greater emphasis on the debt-income ratio of customers.
• Experts believe the new system would cause a reduction in credit scores for low-income customers, while those who have been paying off debt quickly may benefit.

The system of scoring credit, as had been established by FICO, is being updated to give more weightage to the customer’s ratio of debt-to-income. This means that those with a credit score of 600 and below might find their credit scores further reduce once the updated system, called the FICO Score 10 Suite, come into effect towards the end of this year.

According to reports, these updates have been installed to reduce risk experienced by financial service providers as well as improve the underwriting process. FICO estimates that the institutions adopting the Suite 10 would experience an estimated 10%, 9%, and 17% reductions in their default numbers for bank cards, new auto loans, and newly originated mortgage loans, respectively, compared to figures reported under the current system.

This update is not a novel exercise in the FICO scoring system. According to Dave Shellenberger, who is FICO’s VP for product management, the bureau has routinely updated the scoring after every 5 years to improve it. Shellenberger believes that the new update would provide more accurate assessments of the credit risk posed by customers, calling the new scores more powerful than the ones produced under the previous system.

There are two scoring methods available under the updated scoring system, called the FICO 10 and the FICO 10 T. While the FICO 10 is the updated system, the T version has the additional functionality of allowing backward compatibility as well. The T model allows lenders to incorporate new risk-predictive factors into previously calculated credit scores.

However, according to reports, low-income customers are at risk of being adversely impacted by the new system, due to a widening gap between good and bad credit customers. But, FICO has also stated that 40 million customers are likely to experience an improvement in their credit scores as well due to the new model.

The customers who are likely to benefit under the new system include those that have been paying off their debts quickly, while the ones who have been accumulating debt over time are likely to have their credit scores reduced, according to reports.

According to experts, the new model takes a more critical approach towards scoring credit customers, and hence the number of people that would face a reduction in credit scores is likely to be higher than those who will witness improving credit scores.

However, many experts have also praised the new system as a great way to help financial institutions gain a more accurate insight into a consumer’s credit behavior, reducing the risk they take on their overall debt portfolio.

But, experts also foresee that financial institutions are likely to take a significant period of time before adopting the new system due to procedural lags. Also, FICO scores are only part of the assessment process, and hence the impact of the updated system may not be very profound.