What is a significant – and growing – barrier preventing future generations from achieving the American Dream?
One critical answer is the difficulty that millions of people have when seeking to become homeowners. Much of the challenge lies with the traditional credit scoring process, which fails to meet the needs of many individuals who, in fact, have good credit, especially in the Millennial and minority communities that are the future of America. The process prevents them from experiencing the joys and the benefits of homeownership – something that has long been synonymous with the American Dream.
It’s important to understand why homeownership is so important, as well as the hurdles faced by the evolving profile of the American homebuyer.
America’s middle class has traditionally relied on homeownership to create wealth, save for retirement, establish financial security and socioeconomic mobility, and cultivate safe and stable communities. Lawmakers have long understood this, which is why they have historically taken responsible steps to promote homeownership.
It worked. Until the 1990s, the rate of U.S. homeownership hovered between 63 percent and 65 percent. During the 1990s, a number of regulatory, policy, financial and, particularly, demographic trends in the baby boomer generation contributed to a dramatic rise in this rate to a historic high of 69 percent between 1995 and 2005. Since this peak, we have experienced a steady decline, driven by the financial crisis, and changing demographics.
Demographic trends are transforming the country’s landscape. According to First American’s analysis of census data, the collective minority in America – including Hispanics, African-Americans and Asian-Americans – will become the majority of the U.S. population within the next three decades. The fastest-growing ethnic group will be Hispanics, whose rapid growth will proportionately increase demand for homeownership. Another contributing factor will be Millennials, who First American estimates could contribute 20 million first-time home purchases in the coming years. First-time home purchases are, of course, the bedrock for a healthy housing market.
Unfortunately, potential homeowners in these groups are the ones facing the biggest barriers with the current credit scoring system. That system leaves millions of borrowers who practice responsible credit behaviors as “unscoreable” by conventional credit-scoring methods. VantageScore Solutions found that among the 30 million to 35 million consumers who are conventionally unscoreable, 7.6 million consumers actually score 620 or higher using models that use more granular data – a range that could potentially qualify those consumers for a mortgage.
Whichever side of the political spectrum you may be aligned with, the undeniable fact is that there are many consumers on the outside looking in. Indeed, the Urban Institute, Washington, D.C., found that 5.2 million more loans would have been made between 2009 and 2014, if lending standards had been expanded.
This is the crisis that we must fix – the more people who can’t become homeowners, the more people who will struggle to achieve the American Dream.
In order to make the housing market more diverse and inclusive, the industry and lawmakers must broaden the definition of creditworthiness without sacrificing prudent standards and also provide loan products that match borrowers’ financial behavior.
Industry leaders and government agencies are already taking positive steps in that direction. For example, major financial institutions such as Bank of America and Wells Fargo Home Mortgage have recently developed loan programs that provide low- and moderate-income households with an opportunity to become homeowners at an affordable entry point.
Fannie Mae’s HomeReady® program also provides lenders with an opportunity to service low- to moderate-income borrowers. The government-sponsored enterprises’ use of newer, more accurate and inclusive credit scoring models would increase the number of eligible borrowers in the United States without weakening today’s underwriting parameters. These models could expand the annual mortgage lending rate to Hispanics and African-Americans by 16 percent as compared with 2013 levels. Further, by introducing competition and moving away from reliance on a single model, credit-score model developers will have an incentive to continue to innovate to meet the needs of a more diverse population.
Fortunately, Congress has an opportunity to reform this traditional system and expand homeownership for future generations. The Credit Score Competition Act of 2015 and the FHA Alternative Credit Pilot Program both address this barrier to achieving the American Dream.
Homeownership and the American Dream go hand in hand, yet the current credit scoring system is a barrier that prevents future generations from achieving that dream. Breaking this barrier down will benefit millions in the years ahead.
Mark Fleming, Ph.D., is chief economist at First American Financial Corp. Barrett Burns is the president and CEO of VantageScore Solutions.
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