The biggest change to credit scores in years-and what it means for fintechs

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Fair
Isaac Corporation, whose eponymous FICO scores form the bedrock of consumer lending,
is changing the way it calculates people’s credit scores.

One aspect of the update that caught my eye was how the pervasive rating system plans to treat personal loans, a burgeoning business for banks and borrowers. This is the first time FICO will break out the loan type as a separate category, distinct from auto, mortgage, or student loans.

In
the new system, people who take out personal loans will be eyed with a bit of
suspicion. Previously, consumers could take out a personal loan, consolidate their
debt from outstanding credit card balances, and immediately be rewarded with a
credit score bump. That will no longer be the case when the new rules roll out,
expected in August or September.

So long quick hit highs. FICO is gaining greater visibility into people’s personal finances; the result will smooth out bumps. Instead of seeing only a static picture of how much credit a consumer is using at a given point in time—a situation that overemphasized sudden big changes, like the debt consolidation tactic described above, or the appearance of large expenses related to a big trip—the company will be able to tell whether people’s overall debt levels are trending up or down over a rolling two-year period. In other words, if a borrower is just shifting debt around without actually paying down the total, that person is going to get dinged harder.

I
asked Joanne Gaskin, VP of Scores and Analytics at FICO, whether it would be
accurate to say that banks and financial tech startups, or “fintechs,” had been
gaming the system—exploiting a loophole—to juice consumers’ scores. “Potentially,”
she said.

“From our understanding of the new program, this model could end up hurting the consumer’s credit score,” says Dana Marineau, VP and financial advocate at Credit Karma, which uses VantageScore, a FICO competitor, as the foundation for its free credit score checkups.

Paul Guo, a cofounder of Upstart, a fintech startup that helps banks make lending risk decisions with machine learning technology, says he sees the logic in FICO making these changes. He acknowledges that, on average, people getting personal loans tend to be at a higher risk of defaulting than people who opt for more traditional loans. But, he says, “whenever you paint a whole population with a broad average you may unnecessarily penalize a lot of people.”

“Short term credit hacks like debt consolidation will be much less effective,” says Jason Brown, CEO of Tally, a fintech startup that automates debt repayments. But the new scoring system “stands to benefit consumers who make consistent, steady progress in reducing their credit card debt over time,” he says.

I asked Anu Shultes, CEO of LendUp, whether she expects prospective customers to reconsider taking out personal loans from startups such as hers, given the elimination of that short-term credit score boost. She described the point as “a moot one.” “LendUp’s customers are already shut out of mainstream financial services products,” she says. If people are going to have a harder time getting traditional loans, they’ll have little choice but to opt for alternative lending products like hers.

Brian Walsh, a certified financial planner at SoFi, another personal finance firm, advises people “not to overreact” to the changes. “Your credit score is important, but it is more important to practice sound financial habits such as living below your means, having an emergency fund, using debt responsibly, and saving for the long term. It’s solid advice in any scenario.

A question for you, dear readers: What do you think of the credit score changes? Would you consider taking a personal loan, or have you already done so? What was your experience? Will you reconsider doing so in the future?

Shoot us a line. We would love to know your thoughts.

Robert Hackett

@rhhackett

robert.hackett@fortune.com

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