Rethinking the mortgage monopoly
This Monopoly Is Holding Back the Mortgage Market
Credit scores aren’t working the way they should.
If you apply for a mortgage in the U.S., chances are your credit score will be generated by an algorithm better suited to the economy of the 1990s — part of an ossified system that could be denying millions of otherwise qualified Americans the opportunity to buy a home.
Regulators are considering an update. What’s really needed is a rethink.
Perhaps no number is more important to U.S. consumers than their credit score. It can determine everything from the size of the required deposit on a rental apartment to the interest rate on an auto loan. When they work well, credit scores grease the wheels of the economy by giving businesses a rough first sense of who might qualify for a loan or service.
In the mortgage market, however, credit scores aren’t doing their job properly. That’s because Fannie Mae and Freddie Mac, the government-controlled entities that guarantee most home loans, have for more than a decade required lenders to use only one score, known as Classic FICO. A product of Fair Isaac Corporation, the biggest player in the credit-scoring business, it was developed using consumer data from the late 1990s.
Much has changed
in the availability and understanding of credit data since the 1990s,
leaving Classic FICO in many ways outdated. For example, it can’t
distinguish between overdue medical and non-medical bills, which have
implications. It also dings people for debt already paid to collectors —
an item that has little predictive value. Thanks to these and other
shortcomings, it can score people inaccurately — or sometimes not at
The Federal Housing Finance Agency, which oversees Fannie and Freddie, is rightly considering moving to a newer model. Candidates include FICO 9, released in 2014, and VantageScore 3.0, produced by a joint venture of the three big credit bureaus. VantageScore’s purveyors say that, by taking a different approach to the available data, it can produce scores for as many as 35 million added Americans. This could help identify a lot of creditworthy borrowers, including blacks and Hispanics, whom conventional models miss.
Rather than choosing a single winner — creating a new monopoly with little interest in changing its methods as circumstances change — the FHFA should encourage more competition. Approve a number of different models and let lenders choose among them. This would give credit-scoring companies an incentive to incorporate the latest data and technology and create an opening for firms that have been exploring unconventional data sources, such as social media and mobile-phone accounts.
Would competing credit-scoring companies engage in a race to the bottom, becoming increasingly lenient to gain market share? That danger needs to be watched, but post-crisis mortgage rules have placed strict limits on the loosening of lending standards. The Urban Institute’s Housing Finance Policy Center estimates that the mortgage market is taking on less than half the risk it did in 2001 before the housing bubble started to inflate.
Maintaining FICO’s monopoly would be convenient for regulators, who otherwise will have to manage and monitor an array of models. But competition is more likely to serve the interests of consumers and the economy.