Understanding FICO 08

Fair Isaac recently instituted changes to its credit scoring formula to "ensure the continued reliability and predictive powers of FICO scores." The new model, named FICO 08 made its way into the credit scoring process back in 2008. The new model replaces the existing FICO model, which has remained relatively unchanged since the 1980s.

In this article, we're going to explain how FICO scores are developed, and how they are used by the three major credit reporting agencies. We'll also talk about the changes to the credit scoring formula, which were released in FICO 08. Finally, we'll finish up with a brief discussion outlining the controversy surrounding this new FICO model.

Calculating FICO Scores

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We covered this topic more thoroughly in our article on FICO Credit Scores, but it's worth a quick reminder that the FICO scoring model calculates creditworthiness based on information in five dimensions:

Payment History (35% of score) - account payment information for credit cards, lenders, and retailers. Used to measure your ability to pay your bills on time.
Amounts Owed (30% of score) - the total amount of credit you have outstanding relative to the maximum amount creditors are willing to extend to you.
Length of Credit History (15% of score) - a measure of the length of time your accounts have been open with creditors and lenders.
New Credit (10% of score) - the number of times you applied for credit in the recent past.
Types of Credit (10% of score) - this is the diversity of credit you have in your portfolio.

By making the calculation of FICO scores somewhat transparent to consumers, it's easier for people to understand how their actions can either negatively or positively affect their individual credit scores.

Changes in FICO 08

The primary reason for the switch to FICO 08 had to do with the forecasting powers of the new model. Fair Isaac believes that FICO 08 will do a better job at predicting the likelihood of default on a loan by making two changes:

Authorized Users - An authorized user is a person that is permitted by another account holder to use their account. Normally, this situation applies to a family member who is trying to manage credit for the first time, such as a college student. The new scoring model eliminates "piggybacking," which allowed individuals with bad credit to leverage the payment histories of "stronger" credit card holders by becoming an authorized user on their accounts.
Delinquencies - The second change in the scoring model has to do with payment patterns - especially those that are greater than 90 days late. The FICO 08 model is more forgiving to consumers that are in arrears in one area, but have a number of other accounts that are in good standing.

Fair Isaac predicts the above two changes will reduce the default rates on consumer debt by 5 to 15% for those companies switching to the new model.

Impact of FICO 08 on Credit Scores

Upon hearing of possible changes to the credit scoring process, many consumers will be looking for the answer to the question:

How will FICO 08 affect my credit score?

Keep in mind that credit scores are used by many lenders to determine the amount of credit to extend a borrower. These creditworthiness thresholds are usually based on pre-determined bands of credit scores. To make it easier for lenders to adopt FICO 08, the new scoring model will retain the same numerical range (300 to 850), minimum scoring criteria, and parameters as the prior model.

Credit Score Examples

The following examples help illustrate the rules-of-thumb that apply to FICO 08, and how this model might change individual credit scores:

If you have at least one major account in delinquency, but you also have a number of accounts in good standing with creditors, then your credit score would likely increase / improve with the new model.

If you have at least one major account in delinquency, and you demonstrate a poor payment pattern with several other creditors, then your credit score would likely decrease or deteriorate with the FICO 08 model.

Examples provided by Fair Isaac indicate that consumers might experience a 20 to 25 point adjustment to their credit scores when the above situations apply. As emphasized in other publications, the most effective way to improve your credit score is by ensuring the information used to generate the score is accurate. This includes obtaining a copy of your credit report and looking for errors.

Adoption Rate of FICO 08

When first announced in June of 2007, Fair Isaac believed that lenders would start using FICO 08 as early as September 2007 - when it was first made available to credit reporting agencies such as Experian, TransUnion and Equifax.

TransUnion rolled out the new scoring model in the first quarter of 2009. Equifax began using FICO 08 in June 2009. This rollout schedule followed the settlement with VantageScore, a joint venture that the three bureaus started in 2006.

VantageScore was formed to compete directly with Fair Isaac's FICO scoring system. Fair Isaac is suing the three credit bureaus, accusing them of unfair / anticompetitive practices which are meant to harm the FICO brand.

Experian is expected to begin using the FICO 08 model in 2011.

About the Author - Understanding FICO 08

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