Research of the Week: Expanding Access to Credit
Will new FICO® Score XD make it easier for you to obtain credit?
Each week, Consolidated Credit searches for financial research that can help you deal with your debt and budget. This week…
The interesting study
The credit experts at FICO recently published an extensive whitepaper to assess the viability of their new alternative credit scoring system, FICO® Score XD. This new way of scoring would make it easier for those who were considered “unscorable” under the previous model to obtain credit.
The big result
While 78% of the population can obtain credit under the current FICO scoring model (that’s 190 million people), another 28 million don’t have sufficient data to be scored and another 25 million have no credit bureau file at all. That leaves 22% of the population “unscorable” simply because they haven’t used credit enough to be scored properly or because they’ve gone inactive when it comes to credit because they’ve had trouble in the past.
The fascinating details
The FICO researchers identified two main groups of potential borrowers who don’t have access to credit under the current model:
- Those who are “unscorable” because they have no credit file or a limited credit file because they’re new to using credit.
- Those who are “unscorable” because they’ve not used credit recently – either because they faced financial distress in the past that led to too many negative remarks on their credit report or because they simply stopped using credit and “retired” from credit use.
In the past, these consumers were barred from obtaining traditional credit. The reasons why are fairly strong – for instance, these borrowers are three times more likely to default due to nonpayment than scorable consumers. However, some parts of the “unscorable” group are more likely to default than others, so “retired” credit users are much less of a risk than those who stopped using credit because they lost access due to financial distress.
In the new FICO® Score XD, these different types of “unscorable” consumers would be assessed under different criteria. As a result, more of each group of “unscorable” consumers could obtain credit:
- 54% of applicants with no credit file would become scorable
- 43% of “retired” credit users would be able to obtain new credit
- 76% of those who are new to credit would be helped
- 47% of those who lost access would be able to access credit again
Even more encouraging, the pilot test showed that once these “unscorable” consumers obtained credit under the new system, they largely did well with it – building credit until they would even qualify under the traditional scoring system.
What you can do
The world of credit today is often a Catch 22 if you’re not already a regular credit user who’s been responsible with it in the past. If you’re new to the game, you stopped using credit for whatever reason, or you’ve never used credit at all but want to start, it can be difficult to get your foot in the door.
This new scoring model would make it easier to follow the same credit application and use of a scorable borrower. Of course, the tradeoff is that you have to be careful to use it correctly and strategically, because there’s certainly more risk that it can cause problems for your financial stability.
“Managing debt effectively within your budget is not always easy, especially when you start talking about big credit lines or managing multiple lines at once,” says Gary Herman, President of Consolidated Credit. “It takes careful planning and a certain level of strategy to be successful.”
The concern is that those who are “unscorable” now many not be prepared to manage debt strategically. The traditional means of getting credit if you’re unscorable ensures the consumer starts small and builds up to bigger, more complex credit lines.
If you’re unscorable, there is a path you may be able take, but it requires some startup capital. Secured credit lines are generally available to anyone, regardless of credit score or lack thereof, but they require a deposit to open the credit line. Here’s what you need to do:
- Review your budget to make a plan that generates the deposit you need.
- If you don’t have a large sum of extra cash, cut a few discretionary expenses so you can generate the money you need over the next few months.
- Apply for a secured credit card.
- The credit limit will usually equal the amount of money you deposit, so you won’t have a huge credit line, but that’s usually a good thing when you’re first starting out.
- Once you obtain the card, only use the card to make purchases that you can afford to pay off that month – never let your balance carry over.
- After six months of consistent payments, you should have a better credit score that would allow you to obtain a small loan or another credit line.
- Make sure you can comfortably afford any loan payments before you take out the loan and only use credit that you can pay off every month.
- After about a year, you should start getting offers for more traditional credit cards. Choose cards wisely – if you get a rewards credit card, never let balances carry over.
- Credit card debt should only be carried over on a low-interest rate card and should really be avoided. Don’t carry balances from month to month on a rewards credit card or a secured credit card – the interest rates are usually too high.
- If you ever end up with credit card debt that you keep carrying over from month to month that you can’t make a plan to pay off with traditional means, then immediately start exploring alternatives, such as debt consolidation.