Federal Housing Finance Agency Paves the Way for Alternative Credit Scores
The Federal Housing Finance Agency (FHFA) announced that it has approved the use of two alternative credit score models by Fannie Mae and Freddie Mac. This could open more doors for potential homeowners who don’t have enough credit history for a traditional check.
“FHFA expects the implementation of FICO 10T and VantageScore 4.0 to be a multi-year effort,” the agency wrote. “Once implemented, lenders will be required to provide both FICO 10T and VantageScore 4.0 credit scores with every loan sold to businesses. FHFA and the companies will conduct outreach to stakeholders to ensure a smooth transition to the new credit scoring models. »
Fannie Mae and Freddie Mac have used FICO scores for the past two decades. The change has been in the works for years by lenders and the FHFA to implement Section 310 of the Economic Growth, Regulatory Relief and Consumer Protection Act.
The 2018 law, among other things, opened the door to expanding the range of models and credit scores beyond FICO and potentially eliminating this existing standard.
As the the wall street journal noted in 2021, some major financial institutions have abandoned the use of FICO in their lending decisions. The reasons are largely pragmatic. According to many lenders, large volumes of data combined with modern predictive analytics allow them to more accurately determine who could repay a loan and who could not.
Additionally, regulators worry that traditional FICO scores have left too many people in the United States unable to access better lines of credit, forcing them to use more expensive forms. The problem becomes a self-perpetuating cycle. Without the type of home credit, consumers with a positive payment history don’t see it in their credit scores, leaving them with a continued reliance on forms of credit that also won’t be included.
For instance, according to Experian, one of the big three credit rating agencies, VantageScore is a product of all three. But rather than requiring a credit account that’s at least six months old, VantageScore can provide a score as long as there’s at least one account, even if it’s less than six months old. This model also looks at credit usage trends, rather than the most recent, and ignores paid collection accounts.
FICO 10T, which is a newer version of FICO, also looks at trend data over the previous 24 months
But does that mean more people would be eligible for mortgages? It’s hard to say. FICO says that mortgage approval rates could be increased by 5% with FICO 10T without adding additional risk and that mortgage delinquency rates could be reduced by 17% with a threshold of 680 in the new system. But if approvals could increase by 5%, that might not mean below the 680 threshold, because delinquency rates are expected to drop more than the potentially increased number of approvals.
And then there’s the reality of house prices and the need for down payments at higher mortgage rates. Applications have plummeted. It is not clear that a different credit model will end the impact of higher financial barriers to purchase.