For years, FICO credit scores have played a unreasonable role in our lives. FICO, which is used by 90% of lenders in America, determines whether or not we can be approved for a mortgage, auto loan or credit card. It is also used to determine how much we can borrow, and what interest rate we will have to pay if we are approved.
As we all know, the best scores are given to people who always pay on time, have limited credit card debt, no negative collections activity, judgments or previous bankruptcy filings. People lose the most points for missing payments, receiving collection items or filing bankruptcy.
During the 2008 financial crisis, the risk management tools used by lenders proved to be greatly flawed. While our nations largest banks continue to rely upon credit history, new lending startups have started experimenting with alternative methods for underwriting credit risk. None of these lenders have given up using FICO entirely, but they are looking for variables beyond FICO to make better lending decisions. Here are five reasons these new lenders are rapidly trying to find an alternative to FICO:
1. Millennials Are Not Using Credit Cards
On average, more than a third of people under 30 years old do not have a credit card. In order to have a credit score, you need to have some form of credit. Historically, the credit card was the gateway product offered on the steps of the campus bookstore and used to build (or destroy) credit at an early age.
2. Cash Flow Matters
In the years before the financial crisis, the entire lending industry became obsessed with credit scores. If your score was high, you could borrow an almost unlimited quantity. New lenders are looking increasingly at cash flow in their underwriting. They want to know how much money you make each month and how you much you spend. If you can afford to add a loan payment to your monthly budget, they will proceed.
3. Medical Bills Are A Mess
Anyone who has had a medical procedure understands that the medical billing process can be complete chaos. There is often confusion regarding who owes what. And doctors regularly hand off invoices to collection agencies before the billing is settled with the insurance company. This is why new lenders have quickly realized that medical debt should be treated in a completely different way in their underwriting models.
4. Collection Items Are An Even Bigger Mess
Damage is done to your credit score when a collection agency registers an item on your credit report. However, the only way to fix that damage is time. After seven years, the item will fall off your report. And, as the collection item ages, its impact diminished over time. Whether you pay the item or not has no impact on your score.This system is a mess. And new lenders recognize the weaknesses in how collection items are captured, cataloged and stored.
5. Other Signals Are Even More Important
If someone is looking to apply for a mortgage, their ability to save for a down payment and make rent payments on time would be a great indication of risk. However, FICO ignores this. If someone is responsible, and closes credit cards that they no longer want, they can be punished by FICO. If someone pays their utility bills on time, they are demonstrating personal responsibility. And that is ignored by FICO and the credit reports. New lenders are keeping these factors in mind.
What are my options?
If you have an excellent credit score, you will likely have a lot of excellent options at both traditional banks and new lenders. If you feel like you fit into one of the five categories listed above, that does not mean that you have to be excluded from access to affordable credit. Regardless of your score, you can visit www.usmortgagesupport.com to learn more about your options.