Between your net worth, retirement savings, and credit score, there are a lot of important financial numbers to keep up with in your adult life. However, much of your ability to acquire assets and be seen as financially healthy revolves around one number even more so than the rest: your credit score.
One credit scoring system, the infamous FICO, has seemed to lead the pack for multiple decades now. Why? Largely due to its simple yet complex method of aggregating all seemingly relevant credit data into one, nicely-weighted end number between 300 and 850. Simple is good, but one can argue that it's outdated in a way that may be exclusive, and the holes in FICO’s scoring algorithms may be starting to eat into its lead.
A brief history of credit scores and FICO
Before credit scores, lenders relied more on social proof, word of mouth, and maybe sometimes documentation of payment history or bank statements. Essentially, manual underwriting was the standard.
In 1954 though, Bill Fair and Earl Isaac came together to create Fair, Isaac and Company, which makes up the acronym FICO. Their goal was to create a standardized mathematical way of calculating a borrower’s creditworthiness, and ultimately to help lenders discern the risk assumed by lending to them. FICO considers payment history, amounts owed, length of credit history, new credit and credit mix in its scoring model.
The other individual credit bureaus that collect their own respective data on consumer credit have been around since 1899 when Equifax was founded, followed by TransUnion in 1968 and Experian in 1996.
FICO is slowly losing its strong grip on the market after decades of dominance. Lenders are more and more looking towards a broader variety of data than just a FICO score in an effort to evolve and be more inclusionary. The current FICO data may also be influenced by generational wealth, such as inheriting wealth through homeownership, that many under-represented borrowers don't have equal access to. And as it stands today, 53 million Americans lack any FICO score whatsoever due to a lack of sufficient credit history, amplifying inequalities.
Instead of using past behavior to predict future repayment behavior, researchers suggest credit scoring models should also look at cash flow and payment history on rent and utilities.
Nonprofit data testing center, FinReg Labs, analyzed cash-flow underwriting, which is based on how much money is in your bank account every day over the year. The results showed that it was more predictive than traditional FICO scoring and that using both the FICO score and cash-flow underwriting together offered the most accurate predictive model.
Capital One and Synchrony Financial don’t use FICO anymore in most cases when it comes to consumer loans, and other large institutions like JPMorgan Chase and Bank of America are expanding into more underwriting-like practices as well, like looking at consumer’s habits of paying phone bills or magazine subscriptions.
📚 If you want to understand exactly what goes into your FICO credit score, take this simple bite-sized lesson on it: