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No single credit scoring model represents the marketplace

Dear Colleague:

As a reader of this newsletter, you obviously take an active interest in the world of credit scoring. So you are probably aware that the U.S. Consumer Financial Protection Bureau (CFPB) recently announced settlement orders with two of the national credit reporting companies, Equifax and TransUnion. You may also have noticed that one of those settlements mentioned VantageScore.

We weren’t involved in that process or those settlements, so it wouldn’t be appropriate for us to comment on their findings, but here’s what we know to be true: There is no one credit scoring model that singularly represents the consumer lending marketplace. In addition to all three VantageScore models and the dozens of FICO models that are in use today, many lenders rely on their own proprietary models to grant or manage credit.

In light of the reality that no single credit model is the yardstick used by all, or even most, consumer lenders, consumers should understand that no score they buy or obtain from a free-score web service is guaranteed to exactly match scores from the model or models a lender may consider when making a lending decision. Nevertheless, consumers can benefit greatly by using scores from validated models such as VantageScore’s to monitor their creditworthiness. If consumers adopt habits that improve the score they obtain from any valid model, that should also lead to an improvement in the scores generated by the dozens of other commercial models also used by lenders. The three-digit scores produced by those models are unlikely to align perfectly, but they’ll track directionally, and serve as valuable tools for documenting and reinforcing good credit behaviors.

In light of all that, we were pleased to read The Truth about Credit Scores,” an incisive LinkedIn post by Michael Turner, Ph.D., the CEO of the Policy and Economic Research Council (PERC), which reiterated this message:

“[A] potential unintended consequence from this CFPB enforcement action is that it misleads people into thinking that there is just one score used by lenders. In reality, there are many different credit scores used by lenders, though among credit bureau scores FICO enjoys a dominant position. As a result, even if nationwide [credit reporting companies] were to provide consumers with just their FICO 9 or VantageScore 3.0, a lender will in all likelihood be using their own proprietary scoring model that may only use the FICO or VantageScore scores as inputs.”

Dr. Turner’s analysis is spot-on, and inspired us to invite him to be our guest for a Five Questions profile. Like VantageScore, he and his colleagues at PERC are committed to expanding consumer understanding of credit and credit scoring and pursuing innovations that extend mainstream credit to all qualified borrowers who want it. 

All the best to you in 2017,

 

Barrett Burns

TransUnion:
Subprime borrowing, rate hikes to boost 2017 delinquencies

TransUnion: Subprime borrowing, rate hikes to boost 2017 delinquencies

2017 TransUnion credit performance forecast finds delinquency levels still far below recession levels

Anticipated increases in interest rates and growth in the number of subprime borrowers in the consumer lending market will spur delinquency rates in 2017 for auto loans and credit cards, according to TransUnion’s 2017 consumer credit market forecast. The study also found that serious mortgage loan delinquency rates are expected to drop, while unsecured consumer loan delinquencies are expected to see only a minimal increase this year.

“The consumer credit markets have been functioning extremely well the last few years, but an increase in subprime lending has begun to impact delinquency levels for some industries, specifically the auto finance and credit card markets,” said Nidhi Verma, senior director of research and consulting in TransUnion’s financial services business unit.

“On the credit card front, we have seen the percent of subprime accounts reach their highest level since the end of 2010; for auto finance, this figure is now at its highest point since the conclusion of 2013,” Verma said. “Our forecast also takes into account an expected 50-basis point aggregate increase in the prime interest rate beginning this December and continuing through the end of next year. The combination of these elements is a key driver of the expected delinquency rate increases.” 

Serious Borrower-Level Delinquency Rates for Key Credit Products*

Credit Product

Q4 2012

Q4 2013

Q4 2014

Q4 2015

Q4 2016**

Q4 2017**

PCT Change in Last 5 Years
 (2012-2017)

Auto Loans 

1.15%

1.23%

1.19%

1.27%

1.36% 

1.40% 

+21.3% 

Credit Cards 

1.75%

1.60%

1.48%

1.59%

1.71% 

1.82% 

+3.7% 

Mortgage Loans

5.38%

4.31%

3.40%

2.46%

2.21%

2.11%

(-60.8%)

Unsecured Personal Loans

3.93%

4.01%

3.73%

3.62%

3.66%

3.72%

(-5.4%)

*Serious mortgage, auto loan, and personal loan delinquencies are defined here as those with payments 60 or more days past due. Serious credit card delinquencies are defined as those with payments 90 or more days past due. **Projections. 

Although delinquency rates are expected to increase for most credit products, mortgage loans will continue a downward trend that has seen delinquency rates drop every quarter since Q3 2013 and declines in delinquency rates for 23 of the last 26 quarters since peaking at 7.21% in Q1 2010.

“The mortgage market has improved dramatically, to a point where it has normalized on a delinquency basis,” Verma said. From an overall consumer credit standpoint, the mortgage marketplace also stands out from other loan types, with prime-and-above borrowers representing a larger percentage of total accounts. This improved risk distribution, coupled with rising home values, has led to a significant decline in mortgage delinquencies.”

Delinquencies expected to remain below recession levels 

TransUnion stressed that the delinquency levels projected for all credit products in 2017, even those that are increasing, will still remain well below the levels observed at the last recession. 

“These projected increases in delinquency are not surprising, nor are they yet a cause for concern,” said Verma. “Lenders are adjusting their underwriting strategies to maintain a good balance between expected losses, consumer credit access, customer utility, and investor returns—and in the end, that balance is a benefit to all parties.”

Comparing Borrower-Level Delinquency Rates: Recession Times vs. Forecasted 2017 Delinquencies

Credit Product

Q4 2009

Q4 2017*

Auto Loans

1.59%

1.40%

Credit Cards

2.97%

1.82%

Mortgage Loans

7.16%

2.11%

Unsecured Personal Loans

4.98%

3.72%

*Projections.

Additional forecast details, including breakout analyses of the credit-card, mortgage, auto-loan, and personal-loan segments, can be found at the TransUnion website.

Why are my credit scores constantly changing?

By John Ulzheimer
The Ulzheimer Group 

One of the most common questions I receive has to do with the changing nature of credit scores. One month, one of your scores is, say, 700, and the next month it’s either higher or lower; it’s rarely the same. What is the explanation for this natural ebb and flow?

First things first: let’s dispense with a pesky myth about credit scores. Your credit score isn’t a continuously changing quantity, like temperature or body weight. Your credit score is like a snapshot; it reflects your situation at a given moment in time. As with snapshots, a new score taken weeks, days, or even minutes from now will reflect a different reality – but it doesn’t replace or update the first score; both are accurate reflections of your circumstances at the time they were created.

A credit score is created when it is calculated by one of the three credit reporting companies (CRCs—Equifax, Experian and TransUnion), based on data stored in their respective consumer-credit databases. The only time a CRC calculates your score is when some entity asks for it. Most typically, that entity would be a financial institution, like a bank, or a credit union or credit card issuer to which you have applied for credit or a loan. But landlords and utility companies may also request scores, and you may even request one yourself when you buy a score or check it through a free-score service. Each time someone makes a score request, or inquiry, a new score is calculated using the information in the credit file maintained by the CRC supplying the score. (Some of these inquiries can impact your credit score, but many others, including those you request yourself, cannot.) 

Credit scores are determined by considering a variety of factors from your credit reports, including the presence or absence of derogatory information, your types and amounts of debts, how long you’ve had credit, the variety of information appearing on your credit reports, and how often you apply for credit. These factors represent dozens of different individual metrics, each having some influence on your final three-digit credit score. Continual changes in these factors mean it’s very likely that scores based on each report will differ, at least a small amount, every time they’re calculated. But here’s the catch: because your score isn’t part of your credit reports, you may not even know about changes in your credit score unless you track them over time. 

If you do track your scores over time and discover that they are always different month after month, don’t panic. Your credit scores will migrate up and down as the information in your credit reports change. Every month, your credit report data becomes older, inquiries age further, credit card balances go up or down, and maybe derogatory information disappears or, unfortunately, lands on your credit reports. All of these things will likely cause your credit scores to be different from the last time they were calculated. This difference in credit scores is perceived as “change,” when in reality your scores have simply been recalculated based on slightly different credit report data. 

If you were to compare the information on your credit reports today to the information on your same credit reports 30 days ago, you’ll likely see many subtle differences, principally to the balances of your credit card accounts. These changes result in a different number of points you’ll earn across the many credit scoring metrics, which is why your scores are likely to be slightly different today than they were at the same time last month.

Did You Know? No credit score can guarantee to be the one your lender uses

Some people believe, incorrectly, that a credit score is only valuable if it’s the same brand, model version, and indeed the exact same three-digit sequence as the score your prospective lenders will see. Here’s why they’re mistaken: 

There are hundreds of credit scoring systems in commercial use by lenders, insurance companies, collection agencies, utility companies, and tenant screening companies. As a result, the chances you’ll obtain a score generated by the same model used to screen your next application are almost zero. 

There are two primary types of scoring models in commercial use today: credit bureau risk models and custom scoring models. 

Credit bureau risk models are exactly what the name suggests—credit scoring models marketed by the three national credit reporting companies (CRCs), which consider only the information that’s on your credit report at the time your score is calculated. There are roughly 70 of these scoring systems commercially available and in use today, including the VantageScore 1.0, VantageScore 2.0, and VantageScore 3.0 scoring models.

Custom scoring model is a broad term that encompasses any scoring system designed and developed for use by a single party, like a lender, or a smaller group of similar parties, like a pool of insurance companies. Almost every mid- to large-sized lender or insurance company uses many different custom scoring models to help in making decisions. Custom models often use scores generated by credit bureau risk models, such as VantageScore, along with information supplied by the loan applicant, such as income, employment history, and personal assets, to evaluate the applicant’s likelihood of defaulting on a loan.

So in fact there is no one score used in banking, insurance, or any other industry. Instead, hundreds of scoring models are used across multiple industries. Because so many models are in commercial use today, it is highly unlikely that any one score a consumer could buy or obtain for free will be derived from the same model, using data from the same CRC, that a prospective lender will use when evaluating a credit application.

What’s more, even in the unlikely event that a score you obtain from a website or credit card statement is produced by the same version of the same model, using data from the same CRC as the one your lender uses, it’s still very unlikely that the score you receive will be the same one your lender gets. The only way to ensure that would be to perfectly synchronize your loan request with the one from your lender, so that scores are calculated at exactly the same instant. That’s because your credit file at each CRC is continually updated, and factors such as the age of your oldest account change each day so that your credit score will naturally fluctuate over time.

No matter what you may read around the blogosphere, no credit score model can promise it will provide you the same three-digit score that a lender will see the next time you apply for credit. 

Five Questions with Michael Turner, CEO, Policy and Economic Research Council (PERC)

Michael Turner

As founder, president, and CEO of the Policy and Economic Research Council (PERC), Michael Turner, Ph.D., is an international expert on credit access, credit reporting and scoring, information policy, and economic development. He has worked on projects in over 25 countries on six continents and has consulted with the U.S. Congress, numerous state legislatures, and government agencies, including the FTC, the FCC, the FDIC, the Federal Reserve Board of Governors, the Council of Economic Advisers, and the White House.

The Score is grateful to Turner for making time to address our questions as he is beginning what promises to be a very busy year in 2017.

PERC’s mission includes addressing the problem of global credit invisibility. How do you define that term, and how extensive is the problem in the U.S. and in the rest of the world? 

Credit Invisibles are those who either do not have a credit file at a nationwide consumer reporting agency—
TransUnion, Experian, or Equifax—or who don’t have enough data in their credit reports to generate a credit score. For most Credit Invisibles, it is virtually impossible to access the affordable mainstream credit needed to build assets through homeownership and/or owning a small business. An estimated 54 million Americans are credit invisible and must have their real credit needs met by high-cost lenders, such as pawnshops, check cashing services, and payday lenders. Globally, we estimate there to be approximately 4.1 billion Credit Invisibles. 

Credit education is a key component of your approach to improving credit access. What are some of the misunderstandings or gaps in knowledge that you consider most important to remedy? 

Nearly half of our credit-eligible population thinks that credit reports and credit scores are different names for the same thing. That is scary! We can all work hard to improve credit reporting and credit scoring, but unless your average borrower understands how their behavior affects each, then they won’t fully benefit. There is clearly a huge need for personalized credit report and credit score education, and the most logical organizations to help educate people are the nationwide consumer reporting agencies.

Your recent article, “The Truth about Credit Scores,” takes the Consumer Financial Protection Bureau (CFPB) to task for unintentionally misleading U.S. consumers “into thinking that there is just one [credit] score used by lenders.” Can you elaborate on the pitfalls of giving consumers that impression? 

This is one of the most enduring, and possibly most damaging myths in the consumer credit market. Most people believe there is just one credit score—a generic credit score. Having any federal government entity perpetuate this myth could distort the credit scoring market. Lenders and investors could erroneously believe that a single score is preferred by the federal government, and they will naturally be inclined to use and/or invest exclusively in that score. This could even become a standard—as is seemingly the case with the GSEs [government sponsored entities, i.e., Fannie Mae and Freddie Mac] concerning residential mortgage underwriting. Ensuring vibrant, robust competition is simply the right policy in credit scoring or in any other market. It fosters innovation, allocates investment dollars optimally, and promotes competitive pricing. All parties win whenever there is choice and competition.

PERC’s study on the Credit Repair Organizations Act (CROA)Is CROA Choking Credit Report Literacy? advocates lifting the act’s provision banning the three major credit reporting companies (Equifax, Experian and TransUnion, referred to in the study as credit reporting agencies, or CRAs) from offering consumers credit education in connection with their credit reports. Can you elaborate on why you’d like to see that change? 

The “why” is simple: we’ve empirically established that people materially benefit from personalized credit education with a national credit bureau—because they are roughly 2.5 times more likely to move into a better risk tier than those who have just had generic credit education. We’ve also established that applying CROA to national CRAs affords no consumer protections. In short, there are real costs to borrowers—especially lower-income borrowers—and no benefits. The solution is easy too. Congress has already created a national architecture for people to directly dialogue with nationwide CRAs about the contents of their credit reports. Presently, owing to an expansive interpretation of CROA (which was never intended to apply to nationwide CRAs), whenever consumers contact a credit bureau and ask how they can improve their scores, they are read an intimidating legal disclaimer, and are forced to wait at least 72 business hours before they can speak to a credit educator at the credit bureau. This makes no sense, and needs to be changed. Let people talk to credit bureaus about how to improve their credit scores without all the barriers. And let other good actors—like Credit Karma and Mint.com—do the same. This would benefit the industry through competition and consumers by making it easy to get expert advice.

PERC is big believer in use of “alternative data” as a means of expanding credit access. How do you define that term, and do you foresee a need for regulations to ensure new forms of data are monitored for quality and consistency, stored securely and applied fairly?

With the advent of “Big Data” and “Smart/Intelligent Data,” the concept of “alternative data” has become diluted. Whenever PERC reports on “alternative data,” we mean nonfinancial payment data, such as energy utility, telecoms, media, rent, and other credit-like regular payments. PERC has conducted cutting-edge empirical research on this topic for more than a decade, in the U.S. and globally. We are currently partnering with the U.S. Department of Housing and Urban Development to study the impact of including public-housing and other rental data in credit reports. These categories of data we now call “traditional alternative data,” as it is structured data. The “fringe alternative data” consists of unstructured data, or so-called Big Data, which includes the meta-variables, tool kits, social media data, etc., that has captivated audiences around the world. The benefits of including traditional alternative data in consumer and commercial credit files are well established, and these assets should be vigorously pursued. It remains to be proven whether unstructured data could be used to protect consumer rights. Regulators should proceed with caution but should also create a space (sandbox) to enable experimentation.

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