If you’ve been frustrated that the credit scoring system has prevented you from getting a home mortgage, 2016 could be a watershed year. Important changes are in the works.
The biggest players in the mortgage field are under pressure by federal regulators and Congress to adopt more inclusive and updated credit scoring models that incorporate non-banking forms of credit, such as rent, utilities and cellphone payments to supplement what’s in consumers’ standard credit files. For people who have “thin” files with minimal data at the national credit bureaus – or no files at all – the changes could bring tangible improvements.
In mid-December, the federal agency that oversees giant mortgage investors Fannie Mae and Freddie Mac ordered both companies to wrap up their plans for adopting “alternate or updated credit scores” this year and move ahead with putting them into action “as appropriate.”
At roughly the same time, legislation was introduced with bipartisan support in the House called the Credit Score Competition Act. Its goal, sponsors said, is to expand access to mortgage money for large numbers of creditworthy loan applicants – especially first-time buyers and minorities – who currently are shut out of consideration by the two companies’ credit scoring practices.
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“Fannie Mae and Freddie Mac are the largest mortgage purchasers in the nation,” said Rep. Terri Sewell, D-Ala., co-sponsor of the bill with Rep. Ed Royce, R-Calif., “but they rely on credit score models that don’t necessarily take into account something as simple as whether borrowers have paid their rent on time. Homeownership is an integral part of the American Dream that shouldn’t be out of reach for low-income, rural and minority borrowers who lack access to traditional forms of credit.”
Royce said the bill would eliminate “the credit score monopoly at Fannie and Freddie,” ending “an unfair practice that stifles competition and innovation in credit scoring.”
Both Fannie Mae and Freddie Mac rely on credit scoring tools from FICO, the dominant supplier of credit analytics for the mortgage industry and best known for its three-digit FICO scores that run from 300 (terrible credit) to 850 (outstanding credit, low risk of default).
The scoring models used by Fannie’s and Freddie’s automated underwriting systems have been in place for years without major updates, critics complain, and do not incorporate more recent, consumer-friendly improvements designed by FICO itself and by competitor VantageScore. FICO Score 9, introduced in the summer of 2014 but never adopted by Fannie or Freddie, provides fairer treatment for millions of consumers whose scores currently are depressed by medical bill collection accounts in their credit files or who have files with scant information because they make little or no use of the traditional banking system. Mortgage applicants whose only major negatives in their credit bureau files are medical collections stand to see their FICO scores improve by a median 25 points, according to the company.
VantageScore LLC, a joint venture started by the national credit bureaus – Equifax, Experian and TransUnion – to compete with FICO, has introduced its “3.0” model that it claims can provide scores on as many as 35 million “previously unscoreable consumers.” The new score is widely used by banks and credit card companies but is frozen out at Fannie Mae and Freddie Mac. The Vantage scoring model incorporates information on a consumer’s rent, utilities and telecommunications payment histories that get reported to one or more of the national credit bureaus. Studies have shown that inclusion of alternative credit data such as rents can significantly improve consumers’ scoring outcomes.
One study by Experian found that out of a sample of 20,000 tenants living in government-subsidized apartment buildings, 100 percent of previously “unscoreable” tenants became scoreable once their rent payment histories were used in calculating their credit scores. Furthermore, the results showed that 97 percent had scores in the “prime” (average 688) and “non-prime” (average 649). Both score categories could help qualify these current renters to obtain home mortgages, provided their income, employment and debt ratios meet Fannie Mae or Freddie Mac underwriting requirements. But that won’t happen until both companies update their scoring models.
What’s the prospect for that? Fannie Mae officials say scoring system changes involve significant costs, not only for the company itself but for the lenders who sell them mortgages. But when Fannie’s and Freddie’s regulator – and maybe Congress – tell them to get moving on it, the odds increase that something good will happen, sooner rather than later.