How do you read or interpret a FICO score? Most banks make a minimum credit score part of the check list of metrics included in their loan approval standards and possibly credit grading, but do you ever take a closer look behind what that score really means? You should.
New York Times’ Gretchen Morgenson wrote a good article about some of the costs consumers (read that “business owners”) incur through faulty FICO scores that are published with impunity by the three major credit agencies. Besides higher interest rates and denied credit, inaccurate reports cost precious time for consumers to track down mistakes they didn’t make and convince a bureaucratic, automated and unconcerned credit reporting agency to correct it. That can take years.
An FTC study of consumer credit reports found at least five percent of all reports contained errors. Of the consumers that disputed their report with the bureaus, only 80 percent received a modified report and only 10 percent saw their score improve. But five percent of those score changes were for +25 points and some more than +100 points.
Why should business lenders care?
Blindly accepting FICO at face value to judge business loan applicants is a long term mistake, chiefly because the score was developed for mortgage lending. Most lenders misunderstand what the report conclusions really mean. Did you know only 35 percent of the score composition was determined by debt repayment? Did you know many borrowers improve their FICO score by getting another credit card or borrowing even more money?
Arguably the FICO Small Business Scoring improves business lender information, but we don’t know how much of that score is based on the basic FICO. Judging applicants too quickly based solely on their FICO score likely costs your bank business it would rather fund.
That said, SBA’s adoption of a scoring model for very small loans less than $350,000 is still a good idea to me, because generally it allows the lending process to scale this market sector, at least so far as those who’ve cleared FICO unscathed. And SBA’s minimum score is fairly low, perhaps taking into account the faulty metrics that many recognize with FICO.
Either way, SBA lenders should take the time to figure out what’s behind bad FICO scores and assure themselves correctly as to whether it’s a bad risk or a bad report.