The Federal Housing Finance Agency (FHFA) announced that it has approved the use of two alternative credit scoring models by Fannie Mae and Freddie Mac. This could open more doors for potential homeowners who haven’t established 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 deliver FICO 10T and VantageScore 4.0 credit scores with each loan sold to businesses. FHFA and the Businesses will engage with stakeholders to ensure a smooth transition to the newer credit scoring models recent”.
Fannie Mae and Freddie Mac have used FICO scores for the past two decades. The change has been in the works for years for 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 credit reporting models and scores beyond FICO and potentially eliminating that existing standard.
Like the Wall Street Journal pointed to 2021, some major financial institutions have stopped using 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 make more accurate determinations of who might repay a loan and who might not.
In addition, regulators have worried that traditional FICO scores have left too many Americans without access to better lines of credit, forcing them to use more expensive forms. The issue becomes a self-reinforcing cycle. Without the property credit type, consumers with positive payment histories don’t see it reflected in their credit scores, leaving them with a continued reliance on forms of credit that won’t count either.
As an example, according to Experian, one of the big three credit rating agencies, VantageScore is a product of all three. But instead of 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 chargeback accounts.
FICO 10T, which is a new version of FICO, also analyzes trend data from the previous 24 months.
But does that mean more people would be eligible for mortgages? It’s hard to say. FICO says so Mortgage approval rates could increase by 5% with FICO 10T without adding incremental risk and that mortgage delinquency rates could be reduced by 17% with a 680 cut in the new system. But if approvals could expand by 5%, that might not mean below the 680 cutoff, as delinquency rates are assumed to fall more than the potentially increased number of approvals.
And then there’s the reality of home prices and the need for down payments at higher mortgage rates. Applications have been falling. It is not clear that a different credit model will end the impact of the biggest financial obstacles to buying.
