Even before the coronavirus pandemic caused state closings and led to one of the fastest recessions in modern history, as many as 60 million Americans struggled to qualify for credit cards and loans.
Early data shows that the restriction will only worsen as the pandemic continues to disrupt daily life, as 39% of national banks say they are already adjusting credit standards for consumer loans and credit cards starting in the second 2020 quarter. That’s a trend. Fair Isaac Corp., the company behind the popular FICO credit score, wants to help mitigate with the launch of its new FICO Resilience Index on Monday.
Similar to credit score, the new FICO Index looks at information from the credit bureau, such as how much credit consumers are using, payment history, number of accounts opened, the length of their credit history, and the amount they currently owe .
But while a credit score is designed to predict a borrower’s credit risk regardless of the current economic environment, the FICO Resilience Index uses those same factors to examine the borrower’s ability to financially weather periods of disturbance or economic volatility. It ranks consumers on a scale of 1 to 99, with the lowest being the best.
The FICO Resilience Index ranks consumers according to their sensitivity to severe economic stress. Consumers with scores in the range of 1 to 44 are seen as the most prepared and able to resist the next economic change.
“It turns out that there are tens of millions of consumers who have lower FICO scores, below 700, who do relatively well in a recession,” Jim Whemann, executive vice president of FICO Scores, told CNBC Make It. “For the first time “We can help lenders and consumers identify those who will be most sensitive to the recession and those who will be well.”
Since the last recession, FICO has been studying more than 70 million consumer credit files to find patterns between those who ended up missing payments and those who didn’t, Whemann says. FICO then used that data to predict which consumers were positioned to best resist economic shocks. If your credit profile is similar to those that were resilient in the past, your FICO Resilience Index score will likely be lower.
The Resilience Index applies different weights to the same factors used in credit scores. But unlike a credit score, delinquencies don’t matter as much, for example. Usually, if you miss a reported payment to a credit bureau and have good credit, it has a big impact on your score because it provides a snapshot of recent activity, Whemann says.
But the Resilience Index score weighs more heavily on other factors, such as low account balances and low utilization of your available credit. “You can have some level of crime and still be very resilient,” says Whemann.
While the credit score is still an important indicator for lenders, it does not take into account what is happening in the economy. Because the Resilience Index score does this, lenders should use both together to get a more accurate picture of what a borrower brings, Whemann says.
With the launch of the index, FICO aims to provide lenders with a better view of potential consumer risk while allowing those with low, but otherwise resilient, FICO scores to continue accessing credit than otherwise they couldn’t get.
“The traditional way of dealing with recessions, and we see it today, is that lenders raise their loan thresholds. They raise their limits. And while that’s obviously the wise thing to do, we’d love for that to be a little bit more sophisticated and surgical and power evaluate some of the people below those limits more accurately, “FICO CEO William Lansing said during an April earnings call.
Initially, FICO will distribute, free of charge, consumer resistance scores directly to lenders who already use the company’s credit scores. There are also plans to develop an option for consumers to check where they are on the Resilience Index and improve their score, Whemann says.
“We are making an effort to see if we can make it digestible and understandable and presented in a way that is useful to consumers,” says Whemann.
Check out: The Beginner’s Guide to Credit Scores: How to Understand and Improve Your Credit Score
Do not miss 110 million consumers could see their credit scores change under the new FICO score
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