Credit Scores: Not-So-Magic Numbers

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steered clear of subprime issues."

Despite Greene's assertions, however, Fair Isaac has announced a sweeping overhaul of the FICO score, its most dramatic ever. The firm promises FICO 08 will be a better predictor of consumer behavior. "The version that's out there today does a fine job," says Greene. "But FICO 08 does an even better job." Greene also acknowledges that Fair Isaac had grown insular, even arrogant, over the years as its hold over the credit- scoring market strengthened. "Customers haven't always liked the way we've behaved as a company," he says. "We haven't always been as customer-centric as we should."

It's unclear, however, whether FICO 08 will address all the problems that hampered the previous version. What's more, the firm isn't rolling out the new score until later this year, and banks won't fully integrate it into their lending models until 2009. Even if the new score is all it's cracked up to be, credit doctors will likely try to manipulate this one, too.

Fair Isaac's basic approach to credit-scoring hasn't changed much since 1956. The FICO score assigns consumers a rating between 300 and 850 based on factors like total debt burden, payment history, types of loans, and the number of times they've applied for credit. (Income isn't a factor.) The median credit score is 723; scores above 800 are considered excellent, while scores below 620 are considered poor.

CREDIT DOCTORS COME CALLING

The firm's first big deals came in the mid-1980s when Diners Club (MA), Bank of New York (BK), and Mobil Oil (XOM) approached it to develop an automated scoring system to assess potential credit-card customers and mail pre-approval letters to those who fit certain profiles. The firm's statisticians created customized models for each, later developing a generic one that any lender could use. Fair Isaac went public in 1986; a decade later mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) began requiring FICO scores on every loan they bought from lenders. Now more than 80% of mortgage lenders use the score. (The big three credit bureaus, which collect people's credit histories, each offer their own scores as well.)

Today FICO's applications go far beyond home loans, however. Insurers look at credit histories to set premiums. Companies pull credit reports as part of their background checks of prospective employees. Retailers analyze FICO scores to find neighborhoods for new stores. And in recent years Fair Isaac has marketed other esoteric models to help casino operators predict which customers are likely to be the most profitable and health insurers to predict which patients are least likely to take their medications.

Meanwhile, as the housing market was heating up, borrowers and lenders were figuring out methods, both legal and fraudulent, to game the scoring mechanism—and Fair Isaac failed to keep pace. Consider the rise of credit doctoring, a legal if highly questionable method for boosting a borrower's credit score. Larry D. Hall, a former drug addict who once lived in a homeless shelter, has made a name for himself on Atlanta's south side as the man to see if you can't get a car loan or mortgage. For $500, Hall arranges for a client to become an "authorized user" on the credit- card account of a retiree with sterling credit, a tactic known as "piggybacking." The method, says Hall, can boost a score by 50 to 100 points within a few months. A study by credit-rating agency Fitch Ratings, which looked at loans with average FICO scores of 686, found that 16% had employed the "authorized user" ruse to boost the applicant's score. Fair Isaac says FICO 08 will close this loophole.

BUSY HACKERS

Yet Hall contends he can raise a troubled borrower's score by 50 to 200 points even without piggybacking.