Rental payment history is a strong indicator of how well a borrower would perform with a mortgage loan. But until this week, these data have been largely left out of the mortgage origination process. Yesterday, August 11, Fannie Mae announced that, for the first time, it will allow rental payments to be incorporated into mortgage applications. This historic announcement comes at a time when wealth disparities have been widening.
Fannie Mae estimates that about 17 percent of first-time homebuyers who were initially ineligible can now be approved, provided they have a clean 12-month rental payment history. Not all mortgage originators are positioned to provide this to their borrowers on launch day. But as technology for incorporating rental payment history becomes more widely available, this expanded access to credit will make homeownership an option for significantly more households.
How is Fannie Mae using the rental payment history?
Under the new guidelines, lenders will submit the mortgage application through Fannie Mae’s automated underwriting system, Desktop Underwriter, just as they do now. If Desktop Underwriter finds the loan is not eligible for sale to Fannie Mae, the system will now check, for all first-time homebuyers, whether a 12-month history of on-time rental payments would change the outcome. If the loan is not eligible as submitted, but 12 months of on-time rental payments would make the loan eligible, Fannie Mae will go back to the lender to let them know, and the lender can ask the borrower to give permission for Fannie Mae to access their bank statements.
After the borrower agrees to submit this information, the lender will order an asset report from a Fannie Mae–approved vendor. The vendor will send a text or email to the customer, who must consent to the vendor accessing the data. The vendor will then access the data and send the data to the lender and Fannie Mae’s Desktop Underwriter system. Desktop Underwriter will automatically assess whether the rental history exists and is consistent with the rental payment amounts on the initial application. If so, the loan will be deemed eligible for sale to Fannie Mae.
Lenders cannot request the bank statements directly. They must order the bank statements through a Fannie Mae–approved vendor. Going through the approved vendor is necessary because bank data are highly confidential, and banks are reluctant to provide access unless they are sure the third-party systems can adequately safeguard it. As a result, banks work with only a limited number of vendors that meet their security criteria. Thus, not all borrowers will initially be able to take advantage of this opportunity at program inception, because few mortgage originators use these vendors.
Although Fannie Mae expects a relatively small number of new mortgage approvals as this new system goes online, we expect this shift to disproportionately benefit Black and Latino borrowers, who, in part because of structural racism, tend to have lower credit scores than white borrowers.
Over time, however, we expect Fannie Mae’s system to expand to allow for more vendors, and we expect more originators to gravitate toward vendors with these capabilities.
Housing payment history is a powerful predictor of mortgage performance
We recently refreshed a study we conducted in 2018 to determine how well mortgage performance (as a proxy for rental payments) predicts future performance. The evidence suggests housing payment history predicts mortgage performance significantly better than credit scores, which is determined principally by the payment history on credit cards and other types of debt.
We examined first-time homebuyers with Fannie Mae–backed 30-year fixed-rate mortgages outstanding in 2016. We classified these mortgages by whether these borrowers missed zero, one, two, or three or more payments. We then looked at how many of these mortgages became 60 or more days delinquent over the next two years, 2017 and 2018. We repeated the exercise for the mortgages outstanding in 2017 and 2018, classifying the loans by pay history and again looking at how they performed over the next two years (2018–19 and 2019–20; the latter included the effect of the COVID-19 pandemic).
Mortgages with no missed payments, even among those with low FICO scores, performed very well over the subsequent two years. Those with a single missed payment fared considerably worse. For example, only 4.0 percent of first-time homebuyers with FICO scores below 700 and no missed payments in 2016 went 60 or more days delinquent in 2017 or 2018, versus 28.4 percent of borrowers who missed one payment in the same FICO score bucket and 11.7 percent of borrowers with FICO scores above 750 who missed one payment.
The pandemic affected the overall magnitude of these results, because the subsequent performance of the 2018 outstanding payments in 2019 and 2020 is worse than in the earlier years. But the original conclusions hold true. The results demonstrate that the performance of the mortgage payment history is the best predictor of future defaults, and this should apply to rental payments. In our earlier study, we showed that for most income groups, monthly gross rents are comparable with monthly costs for homeownership.
Fannie Mae’s incorporation of rental payment history into the mortgage application process will open the doors to homeownership for many buyers who previously would have been locked out. This decision will likely inspire future innovations in mortgage lending that could eventually unlock the door to tens of thousands of otherwise qualified borrowers to become homeowners.