Is FICO Score's Value Diminishing?

According to a Reuters report, as subprime mortgage defaults continue to rise, some lenders are questioning the value of Fair Isaac's FICO score, which measures a consumer's ability to pay back a loan.

In the midst of an unprecedented U.S. housing boom banks and lenders paid a lot of attention to credit scores above all else, often overlooking the income and assets of homeowners looking to refinance and potential homeowners looking to purchase a piece of property. Many home buyers were able to get a loan with a credit score and a written, unchecked statement of income. Traditional down-payment demands were dropped and borrowers were taken at their word because checking a salary took too long. It allowed many unqualified borrowers to get their hands on properties they simply couldn’t afford.

Critics of the system argue credit scores are dangerous to use alone and are easy to manipulate.

Star Tribune reports that a top executive with HSBC Finance, a major subprime lender, told investors that FICO scores were "less effective or ineffective" in predicting behavior during a period of aggressive lending and low interest rates.

Defenders of the FICO score say overaggressive lenders, hungry for profits, are more to blame for the increasing number of defaults among homeowners, because they loosened underwriting standards to take in more marginal borrowers and also sold riskier products such as adjustable-rate mortgages.

In a recent move, however, Fair Isaac Corp. said it would change the way it tabulates its FICO credit score, in order to better predict the behavior of subprime borrowers. The company said an upgraded version of the system will be available in September, which aims to bolster the accuracy of scores by 5 to 15 percent.

(May 18, 2007)