Summary
The FICO score is a valuable component in the underwriting process. However, if a lender uses it to the exclusion of other standard industry best practices, the result will be an under performing portfolio. Create a sound, comprehensive underwriting process and new business volume will be positively impacted and losses will be controlled within expectations.
Analysis
The primary elements of a sound underwriting process for major lenders should include a well developed and maintained proprietary scoring model and validation of critical loan components such as collateral value and borrower ability to pay.
The FICO score is a very important input in the proprietary scoring model--no more, no less. And it is no substitute for sound tools and good processes consistently applied. It is a cop out when a lender blames the FICO score for high loan losses. The tools, techniques and data are readily available to create a scoring model unique to the loan product offered by the lender. That model, if properly constructed and periodically updated, will always out perform the generic FICO score.
And no scoring model will be predictive if the inputs are corrupt. That is why validation of key elements are so important. What should be validated? Here are the key items:
--Is the borrower who he says he is?
--Does he live where he says he does?
--Has he stated his income and debt accurately?
--Has the collateral been accurately valued?
So, the next time you hear a lender blaming loan losses on FICO scores, know that the real cause is basic underwriting deficiencies.
