On paper, permitting competition among credit score model developers in the mortgage industry seems like a no brainer. In other areas, models compete on predictive power, and in turn can better protect lenders (and tax payers!) from unnecessary defaults. Models also compete on inclusivity so they can open up access to credit in a safe and sound manner to historically underserved consumers. Competition can even guard against unfair pricing practices.
Nevertheless, despite Congress passing a law last spring to promote credit scoring competition, we remain stuck in a situation where policies overseen by the federal government created a monopoly, thereby denying lenders a choice in what scoring models they want to use in their businesses.
The good news is that back on May 24, 2018, S. 2155, “The Economic Growth, Regulatory Relief, And Consumer Protection Act” was passed. The Act included Section 310, which amends the Federal National Mortgage Association Charter Act and the Federal Home Loan Mortgage Corporation Act by ordering the Federal Housing Finance Agency (FHFA) to establish standards and criteria for processes used by Fannie Mae and Freddie Mac to validate and approve credit-scoring models in accordance with the bill. Section 310 unambiguously calls for competition in the mortgage marketplace for credit score model developers, for the benefit of consumers and lenders.
Markets need to be open in order for innovation to flourish and/or for new market entrants to push us all to build better models.
A marketplace where lenders can choose among the best models available — and one that is attractive for the next up and coming fintech, start up, or modeling dynamo — will help shepherd the mortgage industry through the next generation of borrowers.
Consider this: a foundational principle of many incumbent credit scoring models is that a borrower have a lengthy credit history and experience handling a variety of different types of credit accounts.
That fundamentally impacts Millennials and GenZers and puts them at a disadvantage. Data shows that these consumers have focused their credit habits around paying off their student loans and as a result have been reticent about applying for new credit accounts.
What would seem to be a prudent financial decision can cause their credit scores to be lower. But this is a solvable problem.
Model developers and data scientists are always thinking about behavioral changes such as this and how we can more accurately score consumers. Without competition, there is no incentive to innovate and adapt as the market changes.
But that’s only half the challenge. The unfortunate result of a lack of competition is that lenders attempt to push the proverbial square peg into a round hole, which is the current circumstance that the mortgage industry finds itself in. The industry remains tethered to one brand of credit scoring model.
In December 2018, FHFA proposed a rule that was supposed to implement Congress’ stated desire for credit score competition. Instead, the proposed rule perpetuates and strengthens the current monopoly by essentially ruling all of the alternatives ineligible.
No one is seeking the substitution of one monopoly for another. It is instead best that that lenders are allowed to choose between multiple GSE-validated credit scoring models and use the model that is most suitable for its business strategies and target customers.
The housing market must adjust to new types of consumers who utilize credit differently than previous generations. This is a strategic imperative.
And FHFA’s future rule may be the sole opportunity the industry has to create a marketplace whereby mortgage lenders and consumers can reap the benefits of credit score competition for the near and distant future.
Op/Ed By Barrett Burns
Barrett Burns is president and chief executive officer (CEO) of VantageScore Solutions, LLC. Prior to joining VantageScore as CEO during its formation in 2006, he was executive vice president at U.S. Trust, heading the National Private Banking Group and a member of U.S. Trust’s Executive Committee and the Senior Management Team of parent company, The Charles Schwab Corporation. Previously, he served as EVP of global risk management and chairman of the Credit Policy Committee at Ford Motor Credit Company, and as SVP and COO of Bank One’s auto finance division, the largest non-captive lender in the U.S. at the time. Burns also spent more than a decade with Citibank, lastly as group credit officer for an international consumer banking division that included operations throughout the U.S. and Europe.