Urban Wire GSE Capital Requirements Inhibit Incorporating Rental Payment History in Mortgage Underwriting
Laurie Goodman, Jung Hyun Choi
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For households who have been left out of or negatively affected by the credit system, research has shown that rental payment history has the potential to safely expand credit, as payment history is a strong predictor of future mortgage payments. Recently, Fannie Mae and Freddie Mac have incorporated rental history into their underwriting, with promising early results. But the Enterprise Regulatory Capital Framework (ERCF), which outlines capital requirements for the government-sponsored enterprises (GSEs), discourages expanding the use of rental payment history.

Historically, the capital requirements for the GSEs and private mortgage insurers, as well as the loan-level pricing adjustments (LLPAs), are based on two factors: a borrower’s classic FICO score, which does not incorporate rent payments, and the mortgage’s loan-to-value (LTV) ratio. The Federal Housing Finance Agency (FHFA) has recently decided to eliminate LLPAs for first-time homebuyers with incomes up to 100 percent of the area median (or 120 percent in high-cost areas) and for homebuyers who qualify for Fannie Mae’s and Freddie Mac’s affordable mortgage programs. About 20 percent of GSE borrowers will see lower mortgage interest rates as a result, but the policy does not cover mortgage insurance.

In October 2022, the FHFA approved the use of FICO 10T and VantageScore 4.0, credit scores that capture rental payment history, but adoption will likely take at least five years. Additionally, less than 5 percent of the updated renter credit scores include rental payment history, and many of these included renters have short histories. While this process moves forward, the FHFA can revise the ERCF and the Private Mortgage Insurance Eligibility Requirements (PMIERs) to allow the GSEs to use positive rental payment history in mortgage underwriting and create more access to homeownership.

Use of rental payment history is a welcome development

In September 2021, Fannie Mae began incorporating rental payment history. If Fannie Mae’s automated underwriting system narrowly rejects a loan and 12 months of on-time rental payments would have made the difference, the GSE will ask lender to get the borrower’s permission to access 12 months of bank statements. Fannie Mae reported in June 2022 that since rent reporting began, it has approved an additional 2,000 borrowers, 41 percent of whom are Black or Latino. Recently, Freddie Mac has followed Fannie Mae’s path, with its Loan Product Advisor systems beginning to consider rental payments in September 2022.

For rental payment history to be considered, the GSEs require a minimum classic FICO score of 620. Borrowers without credit scores, who are disproportionately more likely to be borrowers of color, could likely benefit more than borrowers who have credit scores, but they are not candidates as currently structured. In part, this credit score requirement may have constrained the number of additional borrowers that rental payment history considerations helped.

Capital treatment does not adjust for the decreased risk associated with positive rental payment history

As the GSEs consider how quickly to expand rental payment incorporation, the treatment of capital charges will play a significant role. The current capital treatment under the ERCF derives from FICO scores and LTV ratios, with lower FICO scores and higher LTVs resulting in higher capital charges.

For a borrower with a credit score between 620 and 640 and an LTV ratio between 90 and 95 percent, the base capital charge would equal 151 percent. But if that borrower’s credit score jumped to between 660 and 680 when their rental payment history was factored in, the true capital charge would decrease to 119 percent. We estimate that this would result in about a 109 basis-point cost change to the borrower. The LLPA for the 635 FICO score is 3.25 percent up front, while the LLPA for the 665 FICO score is 2.25 percent, a 100 basis-point difference.

Borrowers Would See a Lower Capital Charge from Including Rental Payment History in Credit Scores

  Formula Estimates
Additional capital held by the GSE = (Capital charge without including rent history – Capital charge including rent history) * Risk multiplier * 8% Capital charge (151% – 119%) *1.0 * 8% = 2.56%
Annual cost to borrowers = Additional capital * (Before tax return – Return on cash) 2.56% * (11% — 2.5%) = 21.8 basis points
Cost, assuming mortgage duration of 5 Years = Annual cost to borrowers * duration of mortgage 21.8 * 5 = 109 basis points

Notes: GSE = government-sponsored enterprise. For the borrower’s credit score without including rent history, we use a 635 FICO score. For the borrower’s credit score including rent history, we use a 665 FICO score. We assume GSEs’ risk multiplier is 1 and before-tax return on capital is 11 percent (after-tax return is 8.5 percent), with the GSEs able to earn 2.5 percent on their funding over the cycle.

By not accounting for a borrower’s history of positive rental payments, a borrower’s mortgage will have a higher capital charge that will translate to the borrower paying a higher LLPA.

In addition, every GSE loan with an LTV ratio above 80 percent must have credit enhancement, which is most often private mortgage insurance. The GSEs set eligibility requirements for the mortgage insurers known as PMIERs, using capital requirements that are based on FICO scores and LTV ratios. Again, borrowers with lower FICO scores pay higher costs because of a perceived probability of default. If the GSEs adjusted for default risk based on past rental payments, borrowers could see lower mortgage insurance costs.

Reexamining capital requirements is necessary for expanded adoption of rent payment history

With the FHFA having already publicly committed to reviewing issues with the ERCF, the agency can take this opportunity to evaluate the lack of capital credit for loans that use rental payment history as well. Similarly, the PMIERs’ capital requirements could be changed to give the borrower and the insurer “credit” for higher-quality loans. 

If the FHFA wanted to give capital credit for loans that use rental payment history while preserving the current ERCF, it could award a certain number of FICO score points to a borrower for a positive rental payment history. More research and data from the current rental payment experience are needed to better calibrate this rental payment “bonus,” but the FHFA could use available data for an initial calibration and improve it as more data become available.

Lastly, both GSEs would like to expand the rental payment history program to allow borrowers without credit scores (who are counted in the below-620 bucket) to provide rental payment history. But the current share of loans without FICO scores among the loans purchased by the GSEs is less than 0.1 percent. Further research and data are needed to map borrowers without credit scores into the ERCF framework. 

Research Areas Housing finance
Tags Credit availability Housing affordability Housing finance reform Housing markets Rental housing
Policy Centers Housing Finance Policy Center
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