Part 2: Common myths about credit risk scores and how to educate consumers
In light of what I've heard in the marketplace through the years, I wanted to provide some information to help 'debunk' some common myths about credit scores.
Myth: There is only one credit score
Reality: There are multiple credit scores that lenders can use to evaluate consumer credit worthiness. As noted in a recent New York Times article, there are 49 FICO score models. Make sure your customers know that an underwriting decision is based on more than just a credit score—multiple factors are evaluated to make a lending decision. The most important thing a consumer can do is ensure their credit report is accurate.
Myth: The probability of default remains constant for a credit score over time
Reality: The probability of default can shift dramatically based on macro-economic conditions. In 2005, a score of 700 in any given model, may have had a probability of default of 2 percent, while in 2009, the same score could have had a probability of default of 8 percent. This underscores the value of conducting an annual validation of the credit model you are using to ensure your institution is making the most accurate lending decisions based on your risk tolerance.
One of the benefits of utilizing the VantageScore model, is that VantageScore Solutions, LLC, produces an annual validation so you can ensure your institution is adjusting your strategies to meet changing economic conditions.
Myth: If the underlying credit report is the same at each credit reporting company, I will have the same score at each company
Reality: Traditional credit scoring models are completely different at each credit reporting company, which leads to vastly different scores or probabilities of default based on the same information. As a risk manager, this is very frustrating, as I may not understand which score most accurately assess the consumer’s probability of default. The only model that is the same across all credit reporting agencies is the VantageScore model, where this is a patented feature that ensures the lender receives a consistent score (probability of default) across all bureau platforms.
I hope these brief examples help clear up some confusion about credit scores. In Part 3 of this series, I will outline how to evaluate the risk of traditionally unscoreable consumers.
If you have any thoughts or experiences from a lending perspective, please feel free to share them below.
CourtesyWhy You Have 49 Different FICO Scores in the August 27, 2012 issue of the New York Times