According to FICO, “the average national FICO Score reached the 700 threshold — some 10 points above what it was just prior to the recession in October 2006.” This represents the highest mark since the company has been tracking the measure, and the first time average scores have reached 700. While lenders use various threshold and score cutoffs based on underwriting strategies and market conditions, a consumer with a 700 FICO is widely seen as a very good credit risk.
Analysts cite a variety of reasons for the improvement in credit scores. Chief among them is sustained U.S economic growth underlined by low unemployment and stable financial markets. Since 2008, lenders have been selective about where they extend credit – particularly among sub-prime borrowers in credit card and mortgage.
Another key factor is growing consumer awareness of credit scores and their impact on financial health. The availability of free credit scores and reports and the ubiquity of credit repair and counseling services has reinforced the importance of a good credit profile.
Another development which is expected to give a boost to credit scores is the decision by the three National Credit Reporting Agencies (NCRAs) to eliminate about 50% of tax liens and all civil judgments from credit reports as part of their National Consumer Assistance Plan (NCAP). FICO estimates 12 million consumers, or nearly 6% of the population, could see an increase in scores. Over 700,000 will see an increase of 40 points or more with the majority seeing a more modest jump of 20 points or less.
While scores are up…so are delinquencies
Somewhat counterintuitively, consumer loan performance has begun to deteriorate. In Q1 2017, delinquencies on indirect auto loans went up 8 basis points to 1.83% while direct auto loans increased 9 basis points to 1.035. Delinquencies in home equity lines rose to 1.11% while the 90-day+ consumer-level credit card delinquency rate increased by 14 basis points to 1.69%. While all of these numbers are still well below historic averages, they indicate a retreat from the exceptionally low default rates lenders have experienced during the most recent economic recovery.
What is a lender to do?
While traditional credit risk models do a good job of helping financial institutions broadly manage and control risk, they can be a lagging rather than a leading indicator of fundamental or systematic changes in the economy. Credit scores built purely on credit bureau tradeline data have two fundamental limitations. Firstly, they ignore a large part of the population who have not had the opportunity to take out a traditional loan, including young people, retirees, and historically underserved communities. So while scores are going up among the mainstream banked population, there is no line of sight into the 50-60 million Americans who don’t have a traditional credit bureau score. Perhaps more importantly, among the scorable population, scores are subject to short-term fluctuations and in some cases manipulation. As more consumers are aware of what drives their credit score, they are better able to adjust short-term behavior in order to present a more positive credit profile to lenders.
Predictive, reliable alternative data helps close the gap left by a traditional bureau-based strategy. In addition to bringing over 90% of the unscorable population out of the shadows, alternative data sources can provide a more holistic, “360 degrees” view of a full-file applicant. Attributes like asset ownership, address stability, professional licensure, and educational history are less immune to the capriciousness of financial tradeline activity. A consumer whose traditional credit score has suffered negatively due to a missed payment or a sudden financial mishap can be offered a second chance based on a better understanding of their overall financial responsibility and health. In times like these, lenders who leverage all tools at their disposal are best positioned to win.