Cut-off score
A cut-off score is the threshold below which a lender declines or refers applications for credit. Lenders set it by comparing expected profit and loss across score bands, and may also apply a bad-rate ceiling. The threshold can differ by segment.
Example
For illustration, suppose a score band contains ten expected good loans for each bad loan, with $100 profit on each good loan and an $800 loss on each bad one. The expected $1,000 profit from the good loans exceeds the $800 expected loss. If this is the lowest band to clear the profit test, it could sit at the cut-off.
Setting a cut-off from profit, loss and a bad-rate ceiling
For each score band, a lender estimates expected profit from good loans and expected losses from bad loans, then compares them. At the margin, odds of 10 to 1 mean profit on a good loan must exceed one tenth of the loss on a bad loan for the band to pass the profit test.
A bad-rate ceiling can constrain the choice before expected profit reaches its maximum. If including a band would exceed the lender’s ceiling, the lender may set a higher cut-off and accept less expected profit. The ceiling is a lender’s policy choice, not a universal threshold.
Different cut-offs, refer bands and other policy rules
A lender may use one cut-off across a population or set different cut-offs by segment or product. The right threshold can differ because the lender’s expected profit and loss by score band can differ across those groups.
A refer band just below the cut-off lets an underwriter review applications in that range. The score is not the whole policy: a lender can set other policy rules beside it, and the score threshold alone does not describe those rules.
Questions we get asked
When should a lender review a cut-off score?
A lender should review it when the score is recalibrated or prices change. A move in losses is another reason to review it, since expected profit by score band may change.
Does a cut-off score guarantee a profitable lending portfolio?
No. The cut-off uses expected profit and expected loss, so it is not a promise of realized profit. Results can differ from those expectations.
Does raising the cut-off mean fewer applications are approved?
On the same score scale, raising the threshold places more applicants below it, so more may be declined or referred under that score rule. Other policy rules may also affect the outcome.
Decisimo’s cut-off calculator finds the most profitable approval cut-off from score bands and shows what a bad-rate ceiling costs.
