Straight from the desk of our CEO, Jeannie Tarkenton
FICO scores: in modern life, your FICO score is one of your personalized numbers, something that tracks you through life stages, like your GPA or your age or your weight. It changes over time as you build a good (or bad) credit history. Used by something like 90% of lenders, from mortgage banks to credit card companies, FICO scores are standardized and easy to interpret. That’s exactly why lenders like them so much.
But are they the right metric for a student loan? In a nutshell – no.
FICO scores: Good for tackling discrimination, but not perfect for everything
In the early days of consumer credit, the first credit-tracking companies began to record personal payment histories and other financial data for individuals. However, they also often tracked discriminatory data, like race, gender, and even political records. Unsurprisingly, lending was openly discriminatory.
In 1970, Congress passed the Fair Credit Reporting Act (FCRA) to regulate the world of consumer credit, in part to protect against discriminatory lending. Credit reporting agencies had to strike discriminatory data from their records, which had to be made publicly available to individuals.
As the industry adjusted to the new rules, lenders grappled with a hodgepodge of credit scores produced by different companies. FICO, a data software company founded in 1958 by an engineer and a mathematician who met at Stanford, was ready to fill the need. Their simple and easy-to-interpret FICO score, launched in 1989, became the industry standard.
In a way, FICO contributed to the decrease of discrimination in lending, which is not eradicated but is down substantially since the 1970s. The mainstream adoption of FICO improved on a process that was blatantly racist, which is enormously important. Numbers and scoring can be accepted as less biased than a human judging another human.
Still, FICO only gives a limited portrait of a borrower. More importantly, overreliance on FICO may limit access to credit for a lot of Americans, especially younger people and those who do not have generational wealth.
FICO puts younger borrowers at a disadvantage
Obviously, the use of FICO can be great, in some ways. But let’s take a minute to look at what your FICO score consists of:
That’s a lot of HISTORY. A full 50% of your FICO score is in some way reliant on building your history. Anyone in the early stages of adulthood who applies for a loan or credit card is dinged pretty harshly on their score right off the bat, just due to age. But you can’t speed up time! In effect, it will always be more difficult and more expensive for young people to borrow money while the FICO-meter adds up to enough time and usage.
This is why so many young people rely on their parents or other adults to co-sign for the things they need early on – student loan, first car loan, first credit card. Before too long, the younger person’s credit starts to look great but it is because they have mom or dad standing beside them as they rack up credit.
So, hmm – that works out well if I am from a well-off family – but if I am on my own, come from a less-than-rich home, or my mom and dad have their own credit problems, this doesn’t work out so well. The very condition of being born low income and from a home without high credit scores makes life more expensive. Interest rates are higher (or not even available!) for a young person in this situation who is seeking loans, a credit card, etc.
Funding U takes a fresh look at young people and credit
These weaker points of FICO are why we have devised our own system of credit assessment at Funding U. We think there are a range of factors and behaviors beyond the FICO score that need to be included when considering who to make loans to. We especially think this applies to young people who have not made poor decisions using credit but simply haven’t had the opportunity to build any history.
Funding U is working to improve this by including academic behaviors in our underwriting. Instead of relying on your FICO, we’ve developed something called the SMaRT score, which measures your academic achievement, course load, likelihood to graduate on time, your job experience, and projected future earnings.
Look, it’s not that we’re FICO-haters – far from it. Credit scores have a rich and interesting history, and are likely going to be an important component of your adult life as you reach important milestones like buying a car and obtaining your first mortgage. But when it comes to evaluating a college student? We think there’s a better way.
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