Which credit score to use? The industry battle is on.
Banks and rival lenders are butting heads over the credit scores used to decide millions of mortgage requests by U.S. home buyers.
Now, a federal agency is weighing whether to step into the fight, which revolves around a longtime requirement for lenders who sell mortgages to Fannie Mae and Freddie Mac to gauge most borrowers using FICO scores. The Federal Housing Finance Agency’s ultimate decision could have wide-reaching ramifications for the mortgage market and home buyers across the U.S.
Many nonbank lenders, which in some recent quarters have accounted for more than half of the mortgage dollars issued in the U.S., want the ability to use a credit score provided by a company owned by credit-reporting firms Equifax Inc., Experian PLC and TransUnion. These lenders argue the alternative score would open the mortgage market to a greater number of people and lead to more mortgage approvals, helping to boost home sales and the economy.
Banks generally want to stick with the current system that uses FICO scores, which have been around for decades and are created by Fair Isaac Corp. Ditching the status quo, they say, could lead to an increase in consumers with riskier credit profiles getting mortgages and a subsequent rise in defaults.
The FHFA, which oversees Fannie and Freddie, is weighing whether to change the requirement to allow for the use of another credit-scoring system. In late December, the agency asked lenders and others for formal input on the issue.
In doing so, the FHFA acknowledged concerns about a “race to the bottom” where credit-scoring systems would compete to offer metrics that make the most loans rather than aspire to be the most reliable.
Credit scores help determine who gets a mortgage and on what terms. They played a role in the last housing boom and bust as lenders lowered credit-score requirements, extending hundreds of billions of dollars of mortgages to subprime borrowers.
After the financial crisis, lenders tightened requirements for potential home buyers. As part of this, they required higher credit scores, making it more difficult for borrowers with spotty credit histories to qualify for a mortgage.
That is why some lenders, mostly nonbank firms, want a change in the kind of scores that can be used. They would like to increase mortgage volume by expanding the pool of borrowers.
These lenders view FICO scores as an impediment since they tend to be more conservative than alternatives.
Nearly half of mortgage dollars made in the U.S. go through Fannie and Freddie, according to Inside Mortgage Finance, so their requirements have huge sway over the mortgage market.
Nonbank lenders argue the current system shuts out borrowers who don’t use credit either out of personal choice or because they went through a bankruptcy or foreclosure. That is where VantageScore Solutions LLC, the scoring firm that Experian, Equifax, and TransUnion launched in 2006, says it can step in.
The company says it can assign a credit score to about 30 million more consumers than FICO. Roughly 7.6 million of those consumers would potentially be eligible for a Fannie or Freddie mortgage, VantageScore says.
VantageScore, for instance, says it will assign credit scores to consumers if they have a credit card or a loan for as little as one month. FICO requires six months. Separately, FICO creates scores for consumers as long as lenders or other entities update information on their credit reports within the last six months. VantageScore says it will go further back than that.
Banks aren’t convinced, even if some big ones have begun to experiment with VantageScore for small pools of applicants whose FICO scores aren’t high enough for a mortgage approval. “We’ve got so much experience using the system we’re using now,” said Gerard Cuddy, CEO of Beneficial Bancorp Inc., a Philadelphia community bank.
The banks’ trade group, the American Bankers Association, says the current system allows for strong underwriting standards. Introducing a new scoring model could put that at risk, said Joe Pigg, senior vice president of mortgage finance at the ABA.
It also could open up mortgage lenders to legal liability, the group says. One feared scenario: If one scoring model is found to approve some borrowers, banks could be accused by regulators of discriminating if they use the other model, Mr. Pigg added.
Nonbank lenders counter that the current system is too rigid and unfairly excludes deserving borrowers. Sanjiv Das, CEO of a major nonbank lender, Caliber Home Loans Inc., said VantageScore could open up homeownership to customers including millennials who don’t have a credit history because of their age.
“I strongly believe that a large number of customers are being excluded because of the slavish reliance on FICO,” Mr. Das said.
Mat Ishbia, CEO of another major nonbank lender, United Wholesale Mortgage, said he was enthusiastic about a possible change. “Doing something just because you’ve always done it that way isn’t a good enough reason,” Mr. Ishbia said.
Both sides agree that Fannie and Freddie’s credit-score requirements need an update, partly because lenders using credit scores must employ an old version of the FICO score.
But the FHFA appears to have doubts about adding a new credit score into the mix. When asked during a congressional hearing in October about new credit-scoring models that can assign scores to people with limited credit histories, FHFA’s Director Mel Watt said, “The notion that there would be substantially more people credit scored and that would increase access if we had competition is probably exaggerated.”
The FHFA has several options as it weighs the debate, including requiring lenders to check credit scores either from FICO or VantageScore; requiring lenders to check both; or allowing lenders to choose between the two scores.
Not all nonbank lenders are urging change. Stanley Middleman, CEO of the large nonbank lender Freedom Mortgage Corp., supports the continued use of FICO, partly because he doesn’t see the point of adopting a whole new system.
“I don’t think people are getting boxed out of homeownership,” Mr. Middleman said. “And I don’t feel like we’re guilty of something by asking people to have a credit history.”