Fight! Fight!
A brawl has erupted, and everyone’s circling around to watch. But instead of being schoolyard fisticuffs, this imbroglio is over which credit score lenders will use for home loans.
For as long as we can remember, lenders used FICO scores to decide whether a borrower qualified for a mortgage loan, which was then sold to the credit giants Fannie Mae or Freddie Mac.
But a rising tide of non-bank lenders are standing up to the FICO bully, and want to instead use credit scores provided by a different reporting company, VantageScore Solutions, one that was created in 2006 by Equifax, Experian, and TransUnion.
This bank versus non-bank imbroglio is squaring off over far more than lunch money, but a bigger piece of the mortgage loan origination market worth hundreds of billions. And while they are swinging away, the Federal Housing Finance Agency is like the teacher running over to break it up. If and when they jump in and mediate, their decision who to send to the principle’s office could have some serious implications for U.S consumers looking to buy a home or take out a mortgage.
The FHFA, which regulates Fannie Mae and Freddie Mac, has always mandated that home loans have to use FICO credit scoring. But in December, they formally opened up the possibility of alternative credit scoring systems bearing influence on mortgage lending decisions, aside from just the Fair Isaacs Corporation.
On one side, banks see no reason to stick with the status quo of using FICO scores. Any change from that, they claim, is welcoming increased risk into the mortgage market, housing market, and the overall economy. If alternative credit scoring models are allowed, they argue, borrowers with riskier credit profiles may suddenly qualify for home loans, and defaults and foreclosures could rise once again.
For that reason, the FHFA, acting as moderator, has expressed worry about shifting to a new model that is less than rock solid, causing a “race to the bottom” for home loan credit scoring.
But non-bank lenders, who are looking to expand upon the current system of only FICO to Fannie and Freddie, say that allowing alternative scoring models would make mortgages more accessible to millions of Americans, giving the housing market a much-needed jolt. In fact, home ownership levels are at their lowest in nearly 30 years, still stagnating while the price of homes and rents skyrockets in many metro markets.
These same non-bank lenders point to the fact that after the last mortgage meltdown and financial crisis, banks tightened their lending standards to an extreme degree, choking the lending pipeline and making it far more difficult for the average American to get a home loan. Now, it’s time to loosen those standards to a reasonable degree and start lending more.
They’re also not pimply-faced geeks without muscle. These non-bank lenders have accounted for more than half of all mortgage loans last year, and see no reason why they can’t hold equal footing when it comes to choosing a new credit scoring system they wish. And, in this case, their credit scorer of choice is not an unknown entity, but a scoring system owned by the traditional credit bureaus Equifax, Experian, and TransUnion.
The brawl continues.
POW! Banks protest that opening up credit scoring to entities other than FICO presents an unnecessary risk – something we should have learned from through the last financial crisis (which was under their watch, by the way.) They also say that messing with the present system could open everyone up to additional legal liability, as new regulations would have to be carefully mapped and navigated so no one could accuse a lender of discrimination based on which model they employed.
SMACK! Non-bank lenders Nonbank lenders counter that the current FICO model unduly penalizes borrowers who either don’t use credit enough or suffered some sort of foreclosure or bankruptcy in the past. Opening credit scoring to Millennials, for instance, who may not have an established credit history but already make up 34% of all homebuyers – the largest demographic in the market – is a necessity, they point out.
VantageScore Solutions is a better alternative, they insist, because it can assign a credit score to about 30 million more American consumers than FICO.
What’s at stake is far more than just bragging rights. Of those roughly 30 million, about 7.6 million would potentially qualify for a mortgage loan with Fannie Mae or Freddie Mac, which would be a huge boon for the housing market, but could extend new mortgage loans worth billions to millions of new-subprime borrowers again if not handled correctly.
The FHFA may step in to break up the fight but is signaling that they’ll err on the side of caution. According to FHFA’s Director Mel Watt, “The notion that there would be substantially more people credit scored and that would increase access if we had competition is probably exaggerated.” Instead, they may look for a more inclusive solution like requiring lenders to use credit scores either/both FICO and VantageScore.
Fight! Fight! We don’t know who will be left standing, but American homeowners will be talking about it (or feeling its effects) for years to come.
