Consumers win with newer scoring models

Consumers win with newer scoring models

Date: June 22, 2020

How Could Homebuyers Benefit from the Use of Newer Credit Scoring Systems?

Credit scoring systems have long been a staple of consumer lending in the United States. For several decades, loans, credit cards and other consumer services have been influenced, to some extent, by the quality of an applicant’s credit scores. A credit score, which is a three-digit number, distills the information from your credit report and helps lenders to predict the likelihood that you’ll pay your bills on time.

Mortgages, like all extensions of credit, are based in part on an applicant’s credit scores. But unlike other types of credit, the choices of credit score brand, type and generation are largely dictated by a third party, the Federal Housing Finance Agency (FHFA). Among other things, the FHFA supervises both Fannie Mae and Freddie Mac, the so-called Government Sponsored Enterprises or “GSEs.” Fannie Mae and Freddie Mac help to fund mortgage loans, thus providing greater access to mortgage funds with competitive terms.

Older Scoring Systems

Credit scoring has been used in mortgage lending since the late 1990s, which sounds like a long time. But the use of credit scores has been ubiquitous in non-mortgage lending for much longer. And unlike credit cards, auto loans, personal loans and other forms of credit, if your mortgage broker or lender wants to run your application through a Fannie Mae or Freddie Mac underwriting system, then the credit scores he or she will have to use will be between 15 and almost 20 years old. If you look through your most recent mortgage loan’s closing paperwork, you will find a Score Disclosure Notice, which will include those older scores.

For historical reference, the scoring models used in mortgage lending were built before the 2008-2009 economic meltdown and subsequent recovery, before at least 14 amendments of the Fair Credit Reporting Act and before at least six newer credit score developments and redevelopments. This certainly isn’t a criticism of any particular credit score or credit score developer as they do not have control over which scores are used in the mortgage market. Nonetheless, there are newer credit scoring tools commercially available that should be used to underwrite your mortgage loan applications.

Newer Scoring Systems

In August 2019 the FHFA released details of a new set of rules that could result in a change in the credit scores used for mortgage underwriting. These rules required the testing of alternative scoring model options for accuracy and reliability with possible approval of their use. The result could be implementation of a newer credit score or a choice of credit score options.

While this is certainly welcome news, the potential use of newer scoring systems won’t happen tomorrow and could actually take years before becoming a reality. Unlike other lending environments, the mortgage industry is full of intermediary players between the application and closing steps. Each of these players would need time to program and adjust for a new credit scoring system.

When you apply for a mortgage loan, the lender or broker will pull what’s called a Residential Mortgage Credit Report or “RMCR” for each applicant. This report is not pulled from any one of the credit reporting companies, such as Equifax, Experian and TransUnion, but is instead pulled from one of a variety of credit report brokers known as Mortgage Credit Reporting Companies (MCRC).

MCRCs have the ability to pull all three of your credit reports and three of your credit scores from the three national credit reporting companies, and then they deliver that aggregate information to the broker/lender and into the Fannie Mae and/or Freddie Mac underwriting systems. Each of these MCRCs would need to update its systems to procure and support the newer scores. And, Fannie Mae and Freddie Mac’s underwriting systems would need to be re-engineered to account for a newer credit scoring model, new Score Factors/Reason Codes and new performance probabilities. Then those newer underwriting systems would have to be redeployed to their respective army of mortgage brokers and lender users, which will take time.

The Upside

This one is easy. The upside of using newer scoring systems is considerable. Newer scoring models are more predictive than older scoring models. That’s an indisputable fact. Low-risk applicants will score higher, and high-risk applicants will score lower with newer models. As such, a move to newer models is a win for the lender because they do a better job delineating based on applicant risk.

Applicants will also win big with newer scoring models. For example, according to VantageScore Solutions, its newest scoring model, VantageScore 4.0, scores some 40 million more consumers than traditional models, and a large percentage of those 40 million would score high enough to qualify for a mortgage loan under today’s guidelines. Newer scoring systems ignore zero-balance collections, discount unpaid medical collections, reward consumers for paying their credit card balances in full each month, and will consider rental and utility payments if they’re on consumers’ credit reports. Older scoring models do none of these things.

Consumer Access

One more thing that cannot be overlooked with respect to this potential upgrading and updating of scores used in mortgage lending is consumer access to these newer credit scores. There has been a considerable trend over the past five to 10 years toward more access to our credit scores. If you have a credit card with almost any large issuer, or if you’re a registered user of a variety of credit management websites, then you have free access to your credit scores.

The scores that are given away by card issuers or by the above-linked websites are either the most current versions or one generation off the most current versions. The scores used today in mortgage lending are not available for free to consumers. If you want to see those scores you have to buy them. Or you have to apply for or prequalify for a mortgage loan, which is an unreasonable option for someone who is simply curious to see what is his or her mortgage lending credit scores.