In Search of High-Definition Credit Scores
As banks tiptoe back into consumer lending, their biggest challenge is discerning good risk from bad. Lenders and credit bureaus are trying to devise new methods to sift through the Great Recession’s legacy of tarnished credit so they can find profitable customers. Some want to know whether a loan applicant pays his car loan before his mortgage. Others are scrutinizing child-care expenses for the first time. “Every bank is looking for more and more ways to understand what is a client’s payment behavior,” says David Bowen, senior vice president at Ohio-based KeyBank, which recently bought a $725 million credit-card portfolio and plans to start issuing cards on its own.
Lenders had “knee-jerk reactions” during the crisis and pulled back credit practically overnight, says Philip Philliou of Philliou Partners, an adviser to credit-card issuers. Now his clients crunch info ranging from checking account activity to payment histories on rent, phone, insurance, and utility bills to determine credit limits.
In July, Fair Isaac (better known as FICO) and the data firm CoreLogic launched a new scoring system that combines traditional credit reports, which include debts like mortgages and credit cards, with information mined from public records and CoreLogic’s proprietary sources. The companies hope this will help solve a market conundrum: Though Fannie Mae and Freddie Mac require minimum FICO scores of 620 for most mortgages, many lenders won’t go down that low for fear they’ll be stuck buying back soured loans later. Armed with new intelligence—such as rent and used-car loan payment histories—banks can feel more comfortable selecting borrowers closer to the minimums, says Joanne Gaskin, FICO’s mortgage practice leader. The company claims that under the new system, 44 percent of U.S. borrowers have sterling credit—that is, scores from 800 to 850. That’s double the number of people as under the traditional FICO system, which relies on an algorithm that predates the recession.
For the better part of a decade, credit bureaus have been expanding their data sources to help evaluate people with little or no credit history. Now even lenders who do not target the so-called subprime market are hungry for that type of information. Take rental payments: “Historically, so many people were homeowners, you didn’t have to worry about renters as much,” says KeyBank’s Bowen. Today, timely rent payments can boost an applicant’s standing in the eyes of a loan officer.
On-time rent payments and other data can balance out problems on a traditional credit report, says Kathy Virgallito from the nonprofit credit counseling agency Apprisen. The flip side is that consumers must be extra-vigilant about all their finances—not just what shows up on credit reports. That can be difficult, as lenders and credit bureaus keep some of the new data secret, meaning people may not even know what goes into their new score and can’t contest inaccuracies or take steps to improve blemishes.
Credit scores are no more than a snapshot of a borrower’s risk at a particular point in time. To assess credit worthiness, lenders are increasingly looking at how an individual’s score has trended over several years. If the numbers are low but rising, that can be a good sign. While Experian has for years offered a way for lenders to evaluate so-called trended data, sales of the product have taken off since the crisis, says Steven Wagner, Experian’s president of consumer information services.
The greater visibility is yielding behavioral insights. Before, people typically paid their mortgages before their credit cards or car loans. Conventional wisdom said this was because of the emotional attachment to the home. Along with property values, that sentimentality appears to have been wiped away by the recession; in the process the payment hierarchy has flipped. People now pay off car loans first and then credit cards, with mortgages coming in third, according to a study by the credit bureau TransUnion. “What people were actually valuing was their home equity,” not the emotional attachment, says TransUnion Group Vice President Steve Chaouki. With this knowledge, lenders are now more comfortable extending car loans to subprime borrowers.
David Robertson, publisher of the payment industry newsletter The Nilson Report, estimates that as many as 15 million people who were previously prime are now subprime. “They had the horse shot out from them—things were fine until they lost their job,” he says. Lenders need to “start dredging the bottom to see if something’s there,” he says.
If they did, they would find people like Mario Rogers. The Riverside, Calif., resident was a prime borrower before he lost his job as a county social worker in 2009. “Prior to being laid off, I took pride in making my payments on time,” he says. His credit score fell at least 200 points as he ran up credit-card debt and lost his house to foreclosure. In July, Rogers finally landed a new job as a security officer at a casino, and he is paying down his cards. He says he has the right ethic and hopes the new credit scoring products will help convince lenders to eventually take a chance on him again.