The next generation of credit scoring - more profits, less losses.

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The next generation of credit scoring - more profits, less losses.
2 years ago
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Although most people would consider themselves to be creditworthy individuals deserving of financial assistance, consumers have a limited opportunity to represent themselves to financial lenders, primarily in the form of a FICO credit score. The Classic credit scoring model designed by the Fair Isaac Corporation (FICO) relies on information such as the number of current open credit accounts and corresponding balances, payment history, credit limit, and even employment verification in order to predict the likelihood that a potential borrower will repay borrowed funds. The resulting score, ranging from 300 to 850, determines a borrower's credit approval and the interest rates on all credit accounts.

Yet, for the growing list of potential borrowers who don't meet credit requirements or have credit histories damaged by missed payments and defaults, a credit score calculation model with a more individualized assessment process might be the key to repairing personal credit and protecting lenders from high-risk borrowers. To address the needs of both borrowers and lenders the Fair Isaac Corporation has developed the FICO NextGen risk assessment scoring models, which are designed to consider detailed distinctions between different types of delinquencies when evaluating credit risk.

The Next Generation of Credit Scoring
Along with TransUnion and Equifax, the Experian Credit Reporting Agency has utilized FICO's NextGen scoring system with the introduction of the Experian/Fair Isaac Advanced Risk Model 2.0. The Advanced Risk Model features a score range of 150-950 and expands on the Classic scoring system by nearly doubling the evaluative variables used to predict an applicant's credit practices in the future.

Currently, the standard FICO model allows limited differentiation between varying degrees of ?ťbad??credit, dividing consumers into 10 comparative scoring segments versus the 18 scoring segments used by the Advanced Risk Model to analyze risk patterns. This means that potential lenders would categorize minor payment lapses separately from serious debt infractions, instead of classifying all consumers with problematic credit accounts as negative high-risk profiles. The Advanced Risk scoring model expands the classifications of satisfactory credit, allowing creditors to approve more consumer profiles and increase profits while also offering precise predictions to reduce profit losses on future delinquent accounts.

Measuring the Benefits
In recent years, Fair Isaac has worked with credit issuers and credit reporting agencies to research the effectiveness of NextGen models, specifically focusing on data retrieved from bankcards. The Experian/Fair Isaac Advanced Risk Model 2.0 has the potential to yield a 20-25% improvement in distinguishing acceptable accounts from future unsatisfactory profiles. In particular, NextGen models have identified 23% more unsatisfactory profiles amongst low-scoring consumer profiles than the standard FICO model, while also increasing credit approvals by 6-10% by reassessing credit histories containing charge-offs and severe delinquencies that have previously been resolved.

Overall, creditors benefit by eliminating probable credit risks while maintaining and increasing the number of open accounts with revolving balances held by creditworthy consumers. However, NextGen models, including the Experian/Fair Isaac Advanced Risk Model 2.0, have only gradually gained introduction into the credit industry because many lenders are unsure of how the switch to a different scoring range and segmentation principle will affect their individual credit approval systems. To address such concerns, Fair Isaac has divided the NextGen scale into score ranges that correspond with the Classic FICO model, so that probability assessments for corresponding score ranges will be the same.

For lenders, finding the right balance between enlarging the customer base and regulating profit loss is an important part of succeeding in the credit industry. For Experian, the Advanced Risk Model 2.0 is the first step in making credit lending practices safer for lenders, more practical, and more considerate of consumer needs, especially in light of a worldwide financial decline. Let's hope that Experian and its competitors possess the innovation to advance the consumer world into a sounder financial future.

By LetterBug
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