Written By: Joel Palmer, Op-Ed Writer
Some people buy the latest versions of products and technology the day they launch. Others are content using outdated models.
For example, many smartphone users will stand in line for the upcoming iPhone 8. Yet there are others clinging to their iPhone 4S.
When it comes to assessing the credit risk of mortgage applicants, Fannie Mae and Freddie Mac are like the consumers who have yet to upgrade from the seven-year-old iPhone 4S.
Only in the case of which credit scores to use, the two entities are still exclusively using a method — FICO 4 — that is more than 20 years old and has been upgraded multiple times.
And the two organizations won’t be upgrading for at least another two years, according to reports quoting the director of the Federal Housing Finance Agency.
Earlier this month, a bi-partisan bill was introduced in Congress that would require Fannie and Freddie to incorporate alternative credit scores. This is the latest piece of legislation over the last several years aimed at creating new ways to assess credit worthiness for GSE-backed mortgages.
The problem with relying solely on FICO 4, according to consumer advocates, is that many potential homebuyers lack a credit history with a consumer reporting agency or don’t have enough of a credit history to even have a score.
The Consumer Finance Protection Bureau has pushed for alternative scores, citing its claim that 45 million people in the U.S. are “credit invisible” or don’t have enough credit history. The traditional FICO score only measures whether borrowers have paid debts such as mortgages, credit cards or other loans.
The Urban Institute has also advocated for different credit scoring models. Its research indicates that the mortgage market is taking less than half the risk it was taking in 2001and less than a third the risk it was taking in 2006. Credit is tightest in the credit score dimension. If credit risk today was the same as 2001, there would have been more than 6 million more mortgage loans between 2009 and 2015. In another research report, we have shown that if the credit score distribution in 2015 were the same as in 2001, there would have been 1.1 million additional loans that year, cumulatively 6.3 million additional loans in 2009-2015.
Newer scores, such as FICO 9, FICO HD, and VantageStar, assess credit risk based on other factors, such as timely payment of utility and phone bills, rent payments, property data and public records. In addition, newer models can de-emphasize medical debt and minimize the adverse effect of collections that were eventually paid in full.
FICO claims that more than half of previously unscoreable credit applicants could be scored using FICO XD. VantageScore says its modelcan score 30 million-plus consumers with minimal data on file at credit bureaus who are unscoreable by older FICO models, and that it could “expand mortgage lending to Hispanics and African-Americans to purchase homes by 16 percent.”
“The credit scoring models used by the GSEs and lenders who sell to them need to be updated,” concluded a recent position paper by The Urban Institute. “The updated models have already been developed; its time to conclude the ongoing studies and modernize the system. Incorporating newer models into the mortgage origination process would allow the market to serve a greater number of creditworthy borrowers seeking to purchase a home.”
So why have Fannie and Freddie not made the switch? Some cite the lingering effects of the 2008 financial crisis, which required a $188 billion bailout of the GSEs from the federal government, which took over ownership.Another cited reason is the cost of updating mortgage underwriting systems.
Melvin Watt, director of FHFA, was quoted as sayingthat using "competing credit scores" could lead to "a race to the bottom with competitors competing for more and more customers.” He also said that 2019 would be the earliest that a switch could be made to accommodate a new platform for mortgage bond market offerings.
About the Author
As an NAMP® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.