Written By: Joel Palmer, Op-Ed Writer
The Federal Housing Finance Agency (FHFA) released a proposed rule to validate and approve third-party credit score models used by Fannie and Freddie Mac.
The proposal is required by Section 310 of the Economic Growth, Regulatory Relief, and Consumer Protection Act enacted in May. The act amended the Fannie Mae and Freddie Mac charter acts and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 to establish requirements for the validation and approval of third party credit score models by Fannie Mae and Freddie Mac.
The act does not require the enterprises to use a third-party credit score model. But if a borrower’s credit score is used for a loan, “that credit score must be produced by a model that has been validated and approved by the Enterprise based on the standards and criteria in the Act and FHFA regulations.”
The proposed rule would establish a four-phase process for a GSE to validate and approve credit score models.
The first phase would be solicitation of applications from credit score model developers. During this phase each enterprise would publish a credit score solicitation. The solicitation would include:
•Dates for the solicitation period
•A description of the information that must be submitted with the application
•A description of the enterprise process for obtaining data for testing.
•A description of the enterprise’s process and criteria for conducting their validation and approval
•Additional information required by the enterprise, subject to FHFA review and approval.
The second phase would involve review of submitted applications. The proposed rule would require the enterprises to determine whether each application submitted is complete and includes all required fees.
The next phase would be a credit score assessment. This phase would test each credit score for accuracy, reliability and integrity outside of the enterprise’s business systems.
The last phase would assess the credit score model in conjunction with the enterprise’s business systems that use borrower’s credit scores as part of criteria for the purchase of mortgage loans.
FHFA said the proposed rule would prohibit approval of any credit score model developed by a company related to a consumer data provider through any common ownership or control. It also would require an enterprise to consider potential conflicts of interest and competitive effects in assessing the costs and benefits of approving any credit score model.
The GSEs currently use credit scores in four ways:
•Some loan purchase programs require a minimum credit score as part of determining eligibility.
•They use credit scores within their automated underwriting systems.
•They publish grids that disclose price adjustments known as Loan Level Price Adjustments (LLPAs) for Fannie Mae, and Post-Settlement Delivery Fees (Delivery Fees) for Freddie Mac. These are based on a combination of the borrower’s representative credit score (currently Classic FICO) and the original loan-to- value (LTV) ratio.
•Credit scores are disclosed investors of enterprise securities, to Credit Risk Transfer (CRT) investors, and in Securities and Exchange Commission (SEC) corporate filings.
Prior to passage of the act, FHFA was evaluating the potential impact of a new credit score model. In July, FHFA announced it would not make a decision on updating the credit score model used by the enterprises and instead would shift its focus to implementing the steps required under the act.
FHFA invites interested parties to submit comments on the proposed rule via FHFA.gov within 90 days of publication in the Federal Register or via mail to FHFA, Eighth Floor, 400 Seventh Street SW, Washington D.C. 20219. FHFA will also hold a webinar on Jan. 9 at 1 p.m. EST to explain the proposed rule and answer questions. Register for the webinar here.
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.