Which is the better scoring system to use for qualifying mortgage applicants and which is the best indicator of potential default.
For a while now, the Federal Housing Finance Agency (FHFA), the agency that oversees Fannie Mae and Freddie Mac, has been evaluating credit scoring systems, beyond FICO, for use in qualifying applicants for loans sold to the agencies or those in pools backed by FHFA. This is now stirring quite a debate.
At issue is not whether enhancements to credit scoring models or increased competition would carry some economic and social benefits (most agree, they will), but who is making the request and why.
FICO, the long-standing model, has been around for some time now and may be getting a little long in the tooth. However, it’s been upgraded, and companies have become accustomed to its use. Many products are tied to its result.
In moving to a new model, lenders on both sides would need to understand the new scoring system and determine how and at what level to tie certain product and borrower acceptance.
VantageScore contends that its model will provide credit scores on more than 30 million additional consumers, with about 7.6 million of these scores being eligible for loans that may be sold to Fannie or Freddie.
This is because the model is supposed to more accurately assess blemished and dormant credit histories and evaluate limited credit histories that may negatively affect first-time homebuyers.
VantageScore argues that, since the model consolidates data from all three credit bureaus, it eliminates scoring differences caused by data discrepancies. It should be noted that VantageScore is owned by the three repositories.
Banks are concerned that the use of the VantageScore will expand credit risk increasing the potential for defaults. The score has yet to be tested in a down market, like the one we experienced in 2007.
The push for the new score is supported by non-bank lenders who, once their loans are sold, do not share equally in the default risk of the loans they originate. Banks still originate many loans as portfolio investments, so default risk is of major concerns.
If FHFA goes the way of VantageScore, we may see a split in what score gets used in the secondary market. Loans going to Fannie & Freddie using the VantageScore, while bank portfolio loans, other non-agency investors and private placement pools still requiring FICO. This could cause some obvious problems for lenders.
We know all too well what can happen when the credit box gets expanded too far. In the noble quest to provide more consumers with financing to increase homeownership, we must be careful not to lose sight of prudent underwriting and the consumer’s ability to repay.
Where might you stand on this issue?