October 26, 2006

Credit Score Confusion

Filed under: Credit Scores,FICO

What’s your credit score?  Well, that all depends on which credit score you’re referring to.  The Fair, Isaac Score, commonly referred to as FICO, is by far the most widely used.  OK, so what’s your FICO score?  Sorry, it’s not that simple.  Are you applying for a mortgage or an auto loan?  FICO has a separate model for both the mortgage and auto industry.  As a matter of fact, there are different scoring models for bankcard, personal finance, and installment loans.  There are also credit scores utilized by insurance agencies.  To top it all off, the credit bureaus will sell you a credit score that some have dubbed FAKOs, because they differ from the FICO scores utilized by lenders.  Let’s take a more in depth look at what this author calls credit score confusion.

In the mortgage industry, the standard is set by Fannie Mae, a leading financial services company offering banks and other mortgage lenders financing and services enabling them to make more home loans to more consumers.  Page 116 of Fannie Mae’s August 2006 “Guide to Underwriting with DU” states: “the credit scores we require in DU are produced from software developed by Fair Isaac Corporation (FICO).  The standard FICO scoring model, known as classic FICO, is available from the three major credit repositories: Equifax Inc., TransUnion, LLC, and Experian Information Solutions”.  The guide lists the following versions of the Classic FICO model as the most up-to-date:

Equifax Beacon 5.0
TransUnion FICO Risk Score, Classic 04
Experian/Fair Isaac Risk Model V2

I have a few observations to make.  First, many mortgage lenders are still using a TransUnion FICO Risk Score, Classic 98 model.  This can, in part, account for a variance in score from one mortgage company to another – even if the credit reports are run on the same day. 

Secondly, Fannie Mae (FNMA) uses the term “standard” with respect to the ‘Classic’ version of FICO, and, as previously noted, the overwhelming majority of mortgage lenders follow FNMA’s suit (so I suppose that fits the definition of ‘standard’), yet, Fair Isaac Corporation has a differing opinion.  Fair Isaac Corp. believes the standard should be NextGen FICO and what’s more, this author agrees.  The NextGen version of FICO provides the following benefits over Classic FICO:

* Does not penalize a borrower for taking advantage of a “90-days same as cash” offer.

* Counts all inquires within a 45 day period as one inquiry (Classic = 14 days)

* Can score a borrower with a 3 month credit history (Classic = 6 months).

* Collections and Public records under $100 are bypassed

* NextGen research has shown a statistical ability to decrease the percentage of bad loans originated. 

So why hasn’t NextGen FICO been adopted by FNMA? Good question.  FNMA has been in regulatory trouble for misstating earnings and, in May of this year, agreed to pay $400 million in fines to settle charges over its misleading financial statements.  The worst of these problems are now behind the mortgage giant, but it seems FNMA has been slow to implement any major changes while in the throes of this accounting scandal. 

To make our credit score story a little more complicated, in March 2006 the big three CRA’s introduced a VantageScore, which they tout as “the new standard in credit risk scoring”.  On October 11, 2006 Fair Isaac Corp. filed a lawsuit in Federal Court alleging that the three CRA’s and a jointly owned entity are in violation of antitrust laws.  According to FairIsaac.com “In its suit, Fair Isaac alleges that Equifax Inc., Experian Information Solutions Inc., TransUnion LLC and VantageScore Solutions, LLC, through their launch and marketing of the VantageScore credit scoring model, are jointly engaging in unfair and anti-competitive practices that harm the FICO® credit score brand and goodwill that Fair Isaac has spent 50 years creating”.

Well, there you have it.  Credit score confusion.  So, what more can be said?  Can’t we all just get along?

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