redesignAnswer: The most fundamental flaw in @FICO credit scoring

Imagine two borrowers.

Borrower 1

  • Has a $20,000 credit limit on 1 card.
  • Is using $5,000 of that credit limit.
  • Makes $25,000 a year.
  • Has no assets to speak of; essentially a net worth of $0.
  • Has a mortgage and a car loan.

Borrower 2

  • Has a $7,500 credit limit on 1 card.
  • Is using $5,000 of that credit limit.
  • Makes $250,000 a year.
  • Has $300,000 in liquid assets.
  • Paid cash for car; mortgage is paid off.

Who is the better credit risk? Most humans would say borrower 2.

But the FICO scoring model would say borrower 1.

The fundamental flaw in FICO is that it doesn’t take into account the income or assets of the borrower. It focuses on things like credit utilization, recent inquiries, etc. Someone who makes $500,000 looking for a $25,000 line of credit is more likely to be able to repay that loan than someone who makes $30,000.

The FICO model has many, many flaws. Another significant one is that it often creates scenarios where doing the economically optimal thing reduces your FICO score. We’ll cover that in a later quiz.

My favorite answer to this quiz was:

they let Smedley influence credit denials to top tier CEO’s. the lies keep spreading even deep into financial institution models. i bet FICO will still let David Marcus have a First Progress secured credit card – Anuj hasn’t moved that deep!

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