In light of consumer loan losses, FICO’s time is over
Of all the abnormal economic conditions we’re experiencing, the increase in consumer loan losses is what’s most perplexing in the eyes of Ent Credit Union’s Chief Revenue Office Bill Vogeney.
In a recent CUManagement article, Vogeney says, after nearly four decades of lending experience in the credit union movement, he has never witnessed such a rapid rise in consumer credit losses in such a short period of time when the nation isn’t going through a recession or experiencing job losses.
What’s to blame? Vogeney has a few ideas, including the effects of inflation the last couple years and the limitations inherent in FICO scores, loan deferral plans, and even credit washing.
Stronger FICO scores made people vulnerable
In the peak years of the pandemic, savings rates went through the roof. The average FICO score increased from 702 to 714. According to the Federal Reserve in October 2022, social distancing led the national savings rate to soar to record-breaking levels. “We estimate that U.S. households accumulated about $2.3 trillion in savings from 2020 through the summer of 2021, above and beyond what they would have saved if income and spending components had grown at recent, pre-pandemic trends.”
With surplus savings comes the ability to pay down debt. Vogeney says the rush of paydowns on credit card balances contributed to what might look like an untrustworthy rise in credit scores. Why untrustworthy? Because the savings boost, driven by government stimulus checks and debt decline of those uncertain times couldn’t last forever. Consumers’ routine financial habits were bound to boomerang as the pandemic eased, especially for those still catching up on more expensive payments like mortgages or car loans.
Per the Washington Post in August, more Americans are falling behind on their car loans and credit card payments than at any time in more than a decade. This is cause for concern as rising borrower costs have made many people financially vulnerable.
As Mark Zandi, chief economist at Moody’s Analytics, framed it in the Washington Post piece: “The increase in delinquencies and defaults is symptomatic of the tough decisions that these households are having to make right now – whether to pay their credit card bills, their rent or buy groceries.” Essentially, consumers are now faced with tough choices at the end of each month as there is not enough to cover all their expenses.
Lending options beyond credit score
It’s confusing when a person’s FICO score – or any credit score for that matter – indicates health, yet they’re stressing over monthly bills, auto loans, and mortgages. The fact is that the current system of credit scores (FICO and Vantage) simply aren’t reliable indicators of a person’s financial health. Vogeney offers a few observations about why credit data may be seeing its last days within the next five years:
- Increased use of third-party, fintech data: In the last 10 years, we’ve seen a rapid evolution of the fintech marketplace and establishing partnerships with credit unions across the country. Fintechs are so far ahead in loan application processing that it’s a disservice to both the financial institution and the membership to continue manual processing. By using fintech driven small-dollar loans, credit unions have improved the safety of digital lending, with evaluations from multiple data points confirming member eligibility and ability to repay. Digital small-dollar loans enable credit unions to evaluate loan applications more effectively while delivering the efficiency that members need.
- More data – rather than just credit scores – was the right move after all: Prior to credit data, lenders largely depended on income and financial stability metrics such as work hours and time in the area. A member’s credit score is only one part of the bigger financial picture. With a more detailed evaluation procedure, application data is making a comeback.
- Getting back to the basics: Over the last 20 years, a number of credit unions deprioritized evaluation metrics like the verification of consumer income on loans while increasingly dependency on credit scores. Removing unnecessary barriers and serving members faster remains critical. Relational underwriting, not credit score, is the answer. That’s the advantage of the evaluation capability of a digital small-dollar loan solution like QCash – a mobile financial tool where a member can reach their credit union for an immediate, secure small-dollar loan whenever and wherever they need it.
Amid this “consumer credit recession,” let’s work towards a more comprehensive approach to helping our members. Let’s make it easy for them to get the help they need when dealing with life events. With our members making tough choices each and every month on what bills to pay, we, the credit union industry, need to provide that lifeline.