Loading...

Everything you wanted to know about credit risk scores but were afraid to ask

August 15, 2012 by Paul Desaulniers

In this three-part series, Everything you wanted to know about credit risk scores, but were afraid to ask, I will provide a high level overview of:

  • What a credit risk score predicts;
  • Common myths about credit risk scores and how to educate consumers; and finally,
  • Scoring traditionally un-scoreable consumers

Part I: So what exactly does a credit risk score predict?

A credit risk score predicts the probability that a consumer will become 90 days past due or greater on any given account over the next 24 months. A three digit risk score relates to probability; or in some circles, probability of default.

An example of the probability of default:

  • For a consumer who has a VantageScore credit score of 900, there is a 0.21% chance they will have a 90 day or greater past due occurrence in the next 24 months or odds of 2 out of 1,000 consumers
  • A consumer with a VantageScore credit score of 560 will have a 35% chance they will have a 90 day or greater past due occurrence in the next 24 months or odds of 350 out of 1,000 consumers

This concept comes to life in light of changes being made on the regulatory front from the FDIC in the new proposed large bank pricing rule, which will change the way large lenders define and calculate risk for their FDIC Deposit Insurance Assessment. One of the key changes is that the traditional three-digit credit score used to set its risk threshold will be replaced with “probability of default” (PD) metric.  Based on the proposed rule, the new definition for a higher risk loan is one that has a 20% or higher probability of defaulting in two years.

The new rule has a number of wide-ranging implications. It will impact a lender’s FDIC assessment and will allow them to uniformly and easily assess risk regardless of their use of proprietary or generic credit risk scoring modes.

In part 2, I will dispel some common consumer myths about credit scores and how lenders can provide credit education to their customers.