Two related questions I’ve been asked recently are: 1) How do you determine who qualifies for a FICO® Score? and 2) Why doesn’t FICO score more people? In this blog post, let’s take a closer look at these questions and begin to demystify the science behind who gets a FICO Score.
Simply put, we need a minimum amount of information available on a credit file to generate a valid FICO® Score. Every consumer who has this minimum amount of information – what modelers call “minimum score criteria” – gets a valid FICO Score. FICO Scores are generated for as many consumers as possible, without compromising reliability or accuracy by generating a score when there isn’t enough information to facilitate a safe lending decision.
Having prudent minimum score criteria is critical because FICO® Scores are heavily used in the financial services ecosystem. Three out of every four mortgages are underwritten with FICO Scores. Approximately 10 billion FICO Scores are pulled every year. These scores help lenders make effective lending decisions, so it is important that the scores can be trusted.
If a credit scoring algorithm had few to no requirements for generating a score, the resulting score could be less reliable, inaccurate or even misleading, with potentially negative repercussions to the ecosystem. For example, this could result in consumers getting less credit than merited or unfairly limiting their credit usage. Or, if consumers default due to taking out larger loans than they can handle, this is harmful to both consumers and lenders.
For the FICO® Score, the minimum score criteria are defined as follows:
- Consumer cannot be deceased
- Credit file needs at least one account reported within the last six months
- Credit file needs at least one account that is at least six months old
Note that the second and third conditions can be satisfied by two different accounts.
I won’t spend much time explaining the purpose of the first criterion – why would you lend to someone who can’t pay back their obligations from beyond the grave? However, the other two conditions merit a deeper discussion.
Since the FICO® Score is a tool that helps lenders assess how a consumer will repay their various credit obligations, you logically need some prior history of repaying credit on the credit report. That’s one way to explain why we would have a lot of heartburn at providing a score on a credit report that is only populated with credit inquiries or public records.
In addition to having enough repayment history, it is important that the information be sufficiently recent. The older the information, the less likely that it is representative of the consumer’s current situation.
Let’s analogize this to my dream job: NBA General Manager. If I were getting ready to select a player for the NBA draft, it would be essential that I have not only a holistic view of the player to make an informed decision, but also a recent view of the player. If I didn’t have access to his performance during his college years, particularly his last year in college, and all I had was older information from his high school years, I would not be in a good position to make an informed decision for my ball club.
Just as a lot can happen to a basketball player from high school through college, a lot can happen to a consumer’s financial situation in a relatively short amount of time. Could a risk manager make confident lending decisions without having any recent information about how consumers were repaying their various obligations? No. And that’s why we need a minimum amount of recent information to generate a FICO® Score.
My analogy is designed to explain at a high level why the FICO® Score relies on minimum score criteria. These criteria are a good thing – they help lenders and consumers alike by facilitating responsible lending decisions.
Ultimately, the question isn’t “Can you produce a score on limited information?” It’s “Can you produce a meaningful score on limited information?”