Outdated credit scores

Mortgage behemoths cling to models that unfairly penalize millions of wannabe borrowers

Jan.January 01, 2017 01:00 PM

Borrowers probably know that their credit score is a crucial factor in their ability to qualify for a mortgage. They might also know that their score can vary depending on the type of scoring model their lender uses. If it’s an old, outdated version, they might get a lower score. If it’s a newer, more advanced model, they’ve got a better shot at being scored more fairly.

That brings up a long-festering controversy: The two behemoths of the mortgage business — Fannie Mae and Freddie Mac — continue to use a credit scoring model that even its developer, FICO, says is not as “predictive” as its much newer models. Worse yet, Fannie and Freddie require that all lenders who want to submit loan applications to them must use the same, outdated technology.

The net result, agree critics from the lending industry, consumer groups, civil rights organizations and even a bipartisan coalition of legislators in Congress, is that many applicants don’t get the credit scores they deserve. Meanwhile, many other consumers — estimates put the figure at more than 30 million — aren’t even scoreable using the models currently employed at Fannie and Freddie. Disproportionately, critics say, these are people who don’t make heavy use of the credit system or are young and don’t yet have much information in the files of the national credit bureaus. Large numbers of them might qualify for a mortgage, say scoring experts, if they were simply given a fair shot.

Fannie’s and Freddie’s government regulator, the Federal Housing Finance Agency, acknowledged the problem two years ago, when it directed the companies to begin examining how to improve their scoring systems. The FHFA told them to “conclude [their] assessment,” and “as appropriate, plan for implementation” of a better approach in 2016.

Since it’s now December and there have been no announcements about possible reforms, it’s appropriate to ask: When are Fannie and Freddie rolling out their new and improved scoring models and what will they look like? The question is especially timely given the release in late November of a new study from the Urban Institute documenting how recent credit standards in the mortgage arena have impacted millions of would-be borrowers.

Researchers found that roughly 1.1 million home-loan applicants were turned down in 2015 because the standards used to evaluate them were much more stringent than they were in the pre-housing-boom era, when defaults were relatively low. Between 2009 and 2015, “lenders would have issued 6.3 million additional mortgages,” researchers calculated, “if lending standards had been more reasonable,” as they were back in 2001.

A major culprit: a big shift toward the highest credit scorers when it comes to mortgage approvals. From 2001 through 2015, the share of borrowers approved for mortgages who had FICO scores above 700 jumped to 66 percent from 51 percent, while those approved with scores below 660 more than halved to just 14 percent from 31 percent. Preliminary figures for 2016 showed that credit scores of approved applicants at Fannie and Freddie averaged between 752 and 754, according to loan technology firm Ellie Mae. That stands well above the average score among all Americans of just 699, according to score developer FICO. (FICO scores range from 300 to 850, with low scores indicating higher risks of default.)

In response to the question, a spokesperson for the FHFA said that Fannie and Freddie continue to discuss their plans for scoring reforms with “a broad range of stakeholders” about the “cost, operational implications, and potential impacts on access to credit.”

Who exactly are some of these “stakeholders” and how do they see this issue? Among the most directly affected are the banks and mortgage companies that deal with the two companies daily. They strongly favor a move to more advanced scoring models to broaden the base of potential home buyers and borrowers without exposing themselves or Fannie and Freddie to higher risks of default.

Michael Fratantoni, chief economist for the Mortgage Bankers Association, said in an interview that “by sticking to old models we are disadvantaging” sizable numbers of consumers. Groups such as Fratantoni’s also want to see the introduction of advanced scoring models from companies other than FICO permitted as an option by Fannie and Freddie. One possible example is VantageScore Solutions, LLC, which offers a rival system now used in most other segments of lending.

“We are on the record for more competition in this space,” Fratantoni said. “We shouldn’t be locked into just one set of scores.”

Nor should millions of potentially credit-worthy consumers.

Kenneth R. Harney is a syndicated columnist.

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