The FICO credit scoring model is used by the majority of lenders when evaluating the creditworthiness of loan applicants. FICO® Scores range from a minimum of 300 to a maximum of 850, and the general idea is that the higher a borrower's score, the less likely they'll be to default on their debts. The exact formula is a closely guarded secret, but we know it incorporates factors like the borrower's payment history, loan and credit balances, and the length of their credit history.
However, the methods used by the FICO scoring model to assess consumer credit risks aren't perfect. For example, the formula only considers the last seven years of the borrower's payment history, but what if the economy was strong during those seven years? Or what if a borrower with a fair credit score had financial habits that would help them withstand a recession?
To address shortcomings like this, Fair Isaac Corp (the company behind the FICO® Score) recently introduced a new type of credit scoring model known as the FICO® Resilience Index.
What is the FICO® Resilience Index?
The FICO® Resilience Index uses many of the same factors as the traditional FICO® Score, such as consumers' payment history, the amount they owe, and more. However, there's one big difference.
The traditional FICO® Score generally assumes no major changes to the economy or to the borrower's financial situation, whereas the FICO® Resilience Index is specifically designed to answer the question of what might happen if a recession were to hit. Intended to work alongside ordinary FICO® Scores, it models how a borrower might handle job loss or other financial disruption.
The FICO® Resilience Index is on a scale of 1-99, with lower scores being better. In other words, a consumer with a Resilience Index on the lower end of the spectrum could be expected to handle a recession or job loss very well financially. On the other hand, a consumer with a high Resilience Index could be more at risk of running into serious financial trouble in such a situation.
Here's how FICO describes the interpretation of Resilience Index scores:
Data source: MyFICO.com.
How lenders can use the FICO® Resilience Index
FICO acknowledges that many consumers with high FICO® Scores might not be well-equipped to handle major financial disruption, while some consumers with borderline FICO® Scores might actually be quite resilient in tough times.
The goal of the FICO® Resilience Index is to give lenders another metric that will give them a better picture of a consumer's true risk level. The Resilience Index could help consumers qualify for credit that they may not otherwise be able to get due to a relatively low FICO® Score.
To be perfectly clear, the Resilience Index isn't intended to replace the existing FICO scoring model, and lenders will likely continue to base loan decisions primarily on the traditional FICO® Score. In other words, if you have a FICO® Score of 800 but your Resilience Index is a bit on the high end, don't be worried that it will disqualify you. It's more that lenders now have an additional tool at their disposal to assess credit risk. That could certainly come in handy when assessing somewhat borderline applicants in turbulent times like the ones we're in now.
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