VantageScore Versus FICO: How the New Credit Rating System May Affect Consumers

The fate of consumers and small business owner's finances is wrapped in their ability to access credit and capital. This is increasingly the case, but still few borrowers are aware of exactly how their credit scores are determined. To further complicate what may already be a confusing picture for many, there is a new competitor on the market that, if it is successful in the market, will give consumers a second credit score in addition to the one they already have.

The current credit industry is something like a pyramid in its structure. At the bottom are the consumers who want to finance a car or new refrigerator. These individuals seek a line of credit through a credit lender, or the bank that will be providing the financing. This bank pays one of three credit bureaus for your FICO credit score. The credit bureau, either Equifax, Experian, or TransUnion, depending on who your lender uses, then pays a company called Fair Isaac.

A consumer's credit score is a calculation of the risk a lender will be taking in loaning the individual money. Equifax, TransUnion, and Experian all track individual's fiscal habits: their debts, payment habits, etc. Their compiled information must be placed into a formula, the FICO formula that Fair Isaac owns, in order to pop out a number that is the consumer's credit score. The FICO model is very widely used. It is the formula vastly preferred by lenders, who find it predictable and reliable. This is understandable; Fair Isaac has been involved in the credit industry for nearly half a century, and 80% of major lenders use their system to calculate credit scores.

The credit bureaus would benefit greatly from not being required to pay the top of the totem pole (FICO) every time they run a credit report. To that end, they have developed and promoted their own credit scoring system, dubbed VantageScore. There are a few differences evident already between the two systems. Most notable to consumers, the VantageScore model employs a different numerical scale than the FICO system. FICO runs from 300 to 850. The VantageScore model runs from 501-990, and is set up in a grade school fashion. 501-600 is an F or failing rating; 601-700 is a D or poor rating; 701-800 is a C or fair rating, etc. While this may seem like a benefit due to its more logical numbering, consumers will now be assigned two different credit scores depending on which system is being used.

Credit bureaus have long complained of Fair Isaac's treatment of those with short credit histories, or who have few accounts. The big three bureaus feel that the FICO model falsely inflates the credit scores of these individuals, meaning that the FICO scoring underestimates the risk that they may pose to lenders. In launching their new VantageScore system, they claim to have more fairly gauged the risk of these individuals. This could likely mean making credit less attainable for these consumers. If this is the case, more young Americans and those who haven't actively beefed up their credit portfolios will hurt from the new system.

The exact differences, benefits, and downsides of the VantageScore system versus the FICO system remain to be seen, but consumers should be watchful of how the credit landscape changes for them based on this new arrival.