FICO announces a new wrinkle in credit scoring today. It's called the FICO Economic Impact Index, and the goal is to allow lenders to take economic trends into account when they look at your credit score.
"What we're trying to do is give lenders the ability to augment the credit decisions that they're making for borrowers and consumers, based on external macroeconomic risk," says Careen Foster, FICO's director of global scoring product management. "We're going beyond the traditional credit bureau risk and marrying up economic risk with that credit bureau risk to give lenders a more comprehensive view of what consumers' risk is going to be."
That sounds complicated but it's pretty simple. In a normally functioning economy, someone with a 620 FICO score will probably behave like the typical consumer with a 620 FICO score. But in a recession with a high unemployment rate, someone with a 620 FICO score might act more like a typical consumer with a 615 credit score. In a booming economy, a 620 might behave more like a 624.
With the Economic Impact Index, FICO will estimate the effect of various economic scenarios on consumers. For example, Moody's Analytics might come up with five scenarios, ranging from "Complete collapse, depression" to "Confidence rebounds, quicker recovery" and shades in between. Then FICO will estimate how those scenarios would affect consumers with credit scores of 600 or 640 or 720 or whatever.
Lenders will be able to choose which scenarios they think are most likely over the medium and long term, and to adjust their credit decisions accordingly. So let's say you have a 638 credit score, and you apply for a home loan with a mortgage lender that forecasts a strong economic recovery. The lender might estimate that you'll behave more like someone with a 642 score than someone with a 638. A 4-point swing doesn't sound like a lot, but it could make the difference between a yes or no decision.
It could work the other way, too. If the mortgage lender forecasts a double-dip recession, it might look at your 642 score and conclude that you're likely to behave more like someone with a 636.
I'm oversimplifying. Lenders won't change your credit score. Instead, they'll adjust their cutoffs for their loan programs. For example, if the lender sets a minimum score of 640 for a particular loan, but it forecasts a strong recovery, it might drop the minimum required score to 636 instead of raising your score by 4 points. The effect is the same.
Lenders will use the Economic Impact Index for other things besides credit-making decisions. They'll use it to assess their loan portfolios and what the expected losses will be, and therefore how much to set aside for reserves.
"Whenever lenders have better tools to make better decisions, they're going to make sure they have the ability to grant more credit because they're able to appropriately price the higher risk credit and focus on the people who have the ability to pay debt more effectively," Foster says. "The better the tools are for the lenders, the better the decisions are going to be made."