Fico 2008

Fico 2008 is the latest credit scoring system designed by the Fair Issac Corporation, which was announced in 2007 for roll out in 2008.  In many cases, it is much the same as the current FICO scoring system that has been the primary device creditors use to rate credit risk among consumer borrowers.  There are a few key differences to FICO 2008, which are aimed at better defining risk and creating a more fair platform for lenders to use to determine their credit terms.  There is quite a bit of hostility toward this new rendition of FICO and there is still no clear indication that the major credit bureaus will embrace the new form or what the
timeline will be before total industry acceptance.  At the time of this printing, we only know that Fair Issac announced the implementation of the new system to begin as early as Spring 2008.

Why The New System

For years, banks and institutions that loan money, have relied on the FICO score to categorize individuals according to their risk in relation to credit terms.  Said differently, Creditors use FICO scores to rate the likelihood that a loan will be paid back according to the terms of the loan or credit line offered.  They also assign interest rates, points and the amount of credit offered
by the risk they take in offering credit to the associated credit score.  It’s an important number and has much to do with how much you can borrow and what it will cost you to borrow. 

But, the FICO score is not a precise science.  It is not even a universally understood calculation. In fact, the exact formula used to create the score is proprietary among the primary credit bureaus (Transunion, Equifax, and Experian) and unavailable to the average consumer.  Due to this, the FICO score has been met with much animosity among borrowers who feel their score in no way represents their likelihood of honoring their credit terms.  Some say the FICO score is unfair and perhaps unethical. 
The banks and credit bureaus answer back that the FICO score is unbiased, fair, and efficient. Nevertheless, Fair Issac, is attempting to modify the score to appease objectors and perhaps to close a loop hole that has recently been exploited by borrowers with low scores who have circumvented the system and improved their FICO score.  Fair Issac’s public statement is that FICO ’08 will“ensure the continued reliability and predictive power of FICO scores.”

What Changed

FICO scores are compiled by data from creditors about individuals’ payment habits and their track record of performing on their debt obligations.  Institutional creditors like banks, credit card companies, retail charge card issuers, utility companies, and basically any large company who offer payment terms to customers will report your payment history to the credit bureaus.  If you’ve ever had to provide you social security number to get payment terms, that creditor is probably reporting your payment habits to the credit bureaus.  The credit bureaus then sell this information back to issuers of credit to use to determine
whether to offer you credit, how much, and at what interest rate.  If your payment history looks good, you will be offered better terms than if your history looks bad, risky, or is unknown.  Even the IRS and the court system report to the credit bureaus.

FICO predicts that this new scoring system will reduce lender default rates by between 5 and 15%, and therefore make their service more valuable to lenders as a more accurate measure of risk. There are 2 primary augmentations with FICO ’08.  The first is potentially beneficial to the average consumer and will make scoring more lenient on one off payment problems. For instance, if a customer has 5 credit lines that are always paid on time and one that shows a payment problem, or an occasional slip, FICO ’08 will be more forgiving on the overall credit score. It will also give more consideration to those with multiple and different credit lines, termed “credit mix.”  This will reward the average small business owner or savvy borrower who shows a certain ability to
manage multiple credit lines, mortgages, car payments, etc.  On the other hand, the new formula will most likely further penalize the individual with several delinquent accounts.

Small business owners often feel they are unduly punished by their scores in the old FICO sense, since they often service more debt than the average consumer, and typically run more business credit through their own personal score.  FICO ’08 would appeal to the small business owner as an improvement but not yet a solution to finding a true measurement of their credit worthiness.

A bigger and more controversial change with FICO ’08 has to do with “authorized users”, often referred to as “piggyback” accounts.  In this scenario, a person with good credit could authorize another person with less perfect credit to become an authorized user on the account. We see this all the time with credit cards where a parent or spouse (primary card holder) allows
their child or spouse (authorized user) to have a credit card linked to the primary card holder’s account. The primary card holder is responsible for the charges and the authorized user is allowed to make credit purchases, essentially risk free, guaranteed by the primary card holder.

According to the old FICO scoring system, this would allow the authorized user to be rated by the credit bureaus much the same way the primary card holder is rated.  Therefore, if the primary card holder maintains the account in good standing (using it often while using less than 40% of the credit offered and always paying on time), the authorized users benefits in terms of a better score.  And in a vacuum, if this were the only credit device the authorized user had, upwards of 80% of their FICO score would be based on someone else’s credit worthiness.  This authorized user could then possibly be approved for a loan at the best terms available based on an inaccurate measure of their history of honoring debt responsibility.

Fair Issac seems to have a big problem with the “authorized user” account loop hole and refer to it often as fraudulent in many cases.  The issue is the subject of much debate as a sub-industry has sprouted around the loop hole and an increasing amount of private credit repair companies offer to repair individual credit by renting good credit accounts to those with sub par credit.  In the case of a spouse or child, the primary card holder may in fact allow the authorized user to charge purchases on the account. 
In the piggy bank scenario, the third party credit repair agent will simply broker a deal to rent the account from the primary card holder for a fee, and add the authorized user to the account.  The authorized user in most cases has no purchasing power only because they don’t get the credit card or any account information. They only get the positive reporting of the card account in their name.

Fair Issac suggests that this form of “piggy backing” credit and the inaccuracies it can produce jeopardizes the reliability of the FICO score and could lead to further defaults.  Fraudulent or not and whether or not piggy backing has had any default impact is yet unknown by the vast majority of people.  We do, however, know that Fair Issac is working aggressively to close the loop hole and doing so much to chagrin of the credit repair industry and to those piggy backers who are genuinely trying to establish their own credit on the basis of their trusting friends and relatives. We also know that Fair Issac encountered competition in 2007 from the credit bureaus themselves who are making a run at creating there own scoring system called VantageScore.

There is no reason to believe that Fair Issac is other than sincere in their attempt to make their service more reliable and valuable with FICO ’08.  Yet FICO ’08 is not without critics and it will no doubt take some time before it is fully implemented and accepted by the lending institutions—if at all.