What do young families in Orange County, California, and Selma, Alabama, have in common? Families in both places struggle to qualify for a mortgage and get into their first home, in part because of overly restrictive credit-scoring systems. Can new scoring models, or data about rent and utility payments, help these families become homeowners?
At an event at the Urban Institute last week, representatives Ed Royce (R-CA) and Terri Sewell (D-AL) discussed the difficulties their constituents have getting their first foot onto the homeownership ladder, whether that means a stick-built house in California or a manufactured home in Alabama. Royce and Sewell cosponsored the Credit Score Competition Act (H. R. 898), designed to encourage innovation in credit scoring through competition among credit-scoring systems for the business of lenders selling loans to Fannie Mae and Freddie Mac (the government-sponsored enterprises).
The representatives stressed the importance of working together on issues of common importance to their constituents, a strategy that requires getting to know and trust each other.
Royce observed general agreement that traditional credit-scoring systems do not serve the needs of homebuyers, especially younger buyers. Speakers from VantageScore Solutions, Experian, and FICO promoted the benefits of updated scoring models, including new insights that resulted in reduced weight given to medical debt.
Pointing to credit scoring’s role as a “gateway” to the mortgage process, Mike Trapanese, senior vice president at VantageScore Solutions, noted that credit scores play a small role in mortgage underwriting.
But scores are critical in determining whether a potential borrower’s loan application will be considered by a lender and what price will be offered, which speaks to two major impacts of credit-scoring innovations:
- High-quality, predictive scoring systems that can increase the number of people (especially those with sparse credit histories) with credit scores, can help increase access to credit.
- We can expand the gateway without increasing mortgage credit risk.
But both Trapanese and Joanne Gaskin, senior director at FICO, emphasized that expanded scoring models were unlikely to immediately create tens of millions of potential new homebuyers, although enabling consumers who were previously unscorable to get a credit score can put them on the road to getting a mortgage.
Trapanese put the number of currently unscorable consumers for whom expanded scoring models would yield a credit score above 620 at 7.6 million, of whom about 3 million probably had an income and credit profiles sufficient to support a mortgage on the median-priced home in their zip code. Gaskin said that expanding access to credit would require nontraditional data outside the three main credit reporting agencies.
Michele Raneri, vice president for analytics and business development at Experian, explained that 80 percent of consumers who first enter the files of credit bureaus were born after 1982. Only 4.4 percent of new entrants start with a mortgage; 64.6 percent start with a credit card. And those who start with a credit card begin their credit score life at an average score of 679, which puts them within range of qualifying for a mortgage, although a single trade line is insufficient credit experience to qualify for a mortgage using automated underwriting systems.
Scoring bureaus need additional, and accurate, data
Although all three panelists were in favor of adding data to the system, they also stressed the importance of the data’s accuracy and integrity. Data from checking accounts were at the top of the panelists’ wish list. The bureaus are also beginning to acquire additional positive payment data from consumers’ rent, telecommunications, and utility accounts to supplement the negative collections data they have long had. These positive payment records provide valuable alternative avenues for low-income people to build good credit.
But, as Gaskin noted, only about 1 percent of consumer files have rent data, 2.4 percent have utility data, and 2.5 percent have telecommunications data. Trapanese added that these data are unlikely to make someone currently credit invisible scoreable, but it may add depth to their credit file as required by many lenders, including the government-sponsored enterprises. But Gaskin noted that some issuers are making low-balance credit cards available to previously unscorable consumers as an on-ramp to mainstream credit, using the expanded-data FICO Score XD.
The importance of accuracy and integrity in data was apparent in the discussion of the National Consumer Assistance Plan, which requires the bureaus, by July 2017, to reject public records data that do not meet high standards of accuracy. Gaskin said that although bankruptcy records will pass the tests to be included, almost all civil judgments and half of the tax liens will be excluded from consumer credit records.
But this will have almost no effect on credit scores because 92 percent of the affected consumers have other derogatory information on their credit file. VantageScore has published a similar analysis.
Modernizing the credit-scoring system, both the models and the data, would be valuable to California and Alabama residents and everyone in between. The industry, Congress, and the Federal Housing Finance Agency are poised to make that happen.