FICO scores are used by 90 percent of lenders when making loan approval decisions. The credit score is now more widely used for non-borrowing activities like apartment rental approvals, cell phone approvals and even deposit requirements for utility companies. As credit is becoming more critical to consumers, those who do not have a credit score are being penalized. FICO’s new scoring model is set to change that.
Who Are Un-Scored Consumers
There are two major classes of consumers who do not have a credit score. These include those who have never had credit and those who previously had credit but have become un-scorable because of previous credit issues in the past.
1) Those with no credit often are young adults who have yet to establish credit, immigrants who are new to the country and those who make all purchases with cash. This group has never had the opportunity to show payment responsibility because they have been unable or unwilling to get a credit card as the entryway to the world of credit.
It is estimated that 25 million consumers are un-scorable because they have never had access to credit. They may pay rent, utilities, and other bills on time, but are not given credit for it because these bills are only reported to the credit bureaus if they are delinquent.
The 2010 CARD Act has resulted in increasing numbers of consumers with no credit. Prior to 2010 college students were given a pass on having to have credit to get credit. The result was the majority of college students obtained credit cards and established credit before completing school. Today that has changed and now many students not only do not have a credit card but many are bypassing bank accounts and using prepaid debit cards and cash instead.
2) Those with previous credit problems are also likely to have no credit score. One of the challenges with credit is that when a person hits a bump in the road and all their accounts become late, there is no opportunity to redeem themselves. . They are shut out from future credit opportunities because they can no longer get approved. As the late payments and charge-offs drop off, they report there are no current payments to show a new commitment to responsible credit management. This often results in the loss of a credit score.
It is estimated that 18 million consumers who had previous scores are no longer scored due to the dynamics of the credit scoring models. Even though you may now maintain a residence and make all payments on time, new lenders will not approve you. This makes it impossible to be rescored without taking on high interest debt in the 30% range. Even high interest loans like pay day and title loans generally do not report to the credit bureaus leaving many high interest debt failing to re-establish credit for consumers.
Traditional FICO Scores
Credit is generally established through accounts that are reported to the credit bureaus. This includes mortgages, car loans, credit cards and student loans, to name a few. Each month, the loan company notifies each of the three credit bureaus (Equifax, Experian and Trans Union), regarding your payment history. Information reported includes the maximum credit line, current balance and any payments credited to your accounts.
For consumers who have credit, this data has proven to be an accurate evaluation of consumer risk for the lender. How likely are you to pay the bill if new credit is extended? That’s the question banks are trying to answer, and the credit score model has granted millions credit based on these parameters.
Lender tightening since 2008 has made credit harder to obtain, even for those using traditional FICO scoring. This has also left a large groups of potentially responsible consumers out of the credit market entirely.
Banks want to lend to low risk consumers and needed a different model to access risk for those who did not currently have credit. Many un-scored consumers want to establish credit but are unable to do so without using different data. In response to these concerns, FICO has tested its new scoring through several major credit card providers with very positive results.
How FICO XD Establishes a Score
The FICO XD is not designed to replace the current credit scoring models, but to supplement it. If you currently have a credit score, the new model will not be used. This was built specifically for consumers who do not currently have a credit score.
The new scoring will evaluate risk for many of the 25 million who currently do not have a score by using new data from companies like utilities, cell phone providers, satellite companies, and some rent payments. These non-traditional companies are now submitting data each month to the credit bureaus in cooperation with the new FICO XD model.
The XD scores will be comparable to traditional scores and will use the same scale from 300 to 850 to determine risk. After 6 months of payment history it is anticipated than consumers will move to a traditional FICO score and gain access to credit based on those standards.
Current results have shown that consumers with a 620 XD score move to approximately a 620 FICO 9 score after 6 months. This means that the XD score is accurately assessing the credit worthiness of those who do not currently have a score. It is also giving banks the opportunity to market to these consumers without increasing their risk for non-payment.
What This Means for Un-scorable Consumers
Consumers who have struggled to get credit will now have the opportunity for credit card approval using the FICO XD score as long as the accounts are in your name. Adding your name to accounts will enable you to be approved for a credit card, and allow you to establish credit once the new scoring is rolled out.
Credit card and car loan providers are expected to use the new scoring when the FICO XD rolls out in the first quarter of 2016. It is anticipated that mortgage lenders will be slow to follow. The good news is that in less than a year consumers who are establishing credit will have a traditional score that will open the door to other lending opportunities.
As with any new access to credit it is wise to be careful about adding new accounts. While it may be easier to get a credit card using on time payments for utilities, credit can still be ruined just as quickly by a few missed payments.