DID YOU KNOW: Many lenders use more than one credit score model
There is a common misperception that lenders only use one credit score model. In reality there are dozens of credit score models available to lenders, and many lenders use more than one model.
According to a 2013 study conducted by the research arm of SourceMedia, publisher of American Banker and other financial publications, in conjunction with VantageScore Solutions, nearly 30 percent of lenders said they use more than one credit score model in their businesses.
Lenders use credit score models in many different business applications. The most obvious way lenders use credit scores is to determine the likelihood that a new loan applicant will become 90 days or more delinquent over the course of 24 months. Becoming 90-days late is also known as defaulting.
A lender may also use credit scores in conjunction with a proprietary model (or custom model) the lender developed for its own use. Proprietary models may use one or more scores generated by generic credit scoring models as inputs, or factors for consideration, along with the lender’s other underwriting criteria, to make lending decisions and set loan terms such as the size of the loan and the interest rate to be charged.
Lenders may also use credit scores to manage loan portfolios by periodically requesting the credit scores of their borrowers in order to understand the likelihood that some borrowers may default.
Lenders might also use credit scores for what is known as account management. Simply put, this is a process by which lenders monitor borrowers individually. If a lender sees a borrower’s credit score going up, the lender might extend additional credit. If a lender sees that a borrower’s credit score is going down, the lender might monitor the borrower’s account more closely, hoping to avoid missed payments or other problems. If a consumer misses a payment, lenders may also reach out more quickly after a missed payment to understand why and try to resolve the circumstance quickly.
And finally, lenders use credit scores to market a credit product. This occurs most frequently in the credit card industry. Credit card issuers will focus marketing efforts at potential borrowers whose credit scores fall within certain ranges. For example, certain cards with high credit limits might be offered to those with high credit scores, while other cards like secured credit cards might be offered to consumers with blemished credit records and lower credit scores.
Lenders may use different credit score models for each of these processes, which is one reason why there are many models available.
It’s also important to understand that models must be updated periodically because consumer behaviors can change. Credit scores can provide early warning signals that, along with other factors, help lenders manage their loss ratios, which is the number of loans that they must write down as a loss. By using a fresh model built on the latest consumer data, lenders can manage and improve loss ratios, and the savings can get passed down to the consumer in the form of lower interest rates.
Of course the opposite can be true as well. If a model is old and breaks down, loss ratios could increase and consumer may bear the brunt of that in the form of higher interest rates.