Credit scores alone are not enough to determine the likelihood of default, Fitch Ratings notes, as a variety of factors can complicate the default risk process. In a report, Fitch discusses how consistency is needed in this process.
“Assessing downside risk of U.S. consumer credit can be more difficult if different versions of credit scores are used when lending, underwriting standards are relaxed amid a supportive economy, or when lenders are reaching for growth,” Fitch Ratings says. “As these dynamics can be exacerbated during an economic downturn, it is essential to view credit scores in combination with other key risk variables to most accurately assess default risk.”
According to Fitch, higher FICO scores are indicative of a more solid repayment history of debt obligations, with a lower probability of default. However, different versions of credit scores have been introduced post-crisis that are not used consistently across asset classes and providers, which complicates comparing these scores and has prevented their widespread use in credit analysis.
Current higher FICO score trends in mortgages are partly attributable to a higher percentage of originations from the prime segment following the financial crisis amid the benign economic environment. Borrowers are paying their bills, as is to be expected given strong labor markets, rising wages, and low unemployment and interest rates. FICO scores are also improving as a result of the extended duration of the favorable economic environment, as past payment history with higher delinquency levels falls off.
Much of the market is reliant on older FICO versions. Fitch notes that the mortgage industry uses older versions like FICO 2, 4, and 5 when assessing creditworthiness for new mortgages and deciding interest rates, while the newer FICO versions are currently not used by the mortgage market. Newer versions, such as FICO 8, which is commonly used in other industries, factors in on-time payments, account balances, and length of credit experience when calculating scores. FICO 9 differs when it comes to collections, factoring in rental payment history while putting less weight on delinquent medical collections.