The credit score — perhaps the most significant factor in mortgage qualification — is outdated and not changing anytime soon.
The Federal Housing Finance Agency (FHFA) has been hard at work examining its preferred credit score model in an attempt to include the many individuals unable to buy a home due to a lack of traditional credit. Now, this effort has been put on hold to focus instead on implementing measures of the President’s Economic Growth, Regulatory Relief, and Consumer Protection Act (the Act).
The FHFA, charged with overseeing Fannie Mae and Freddie Mac, is a key player in the housing market. Its decision to put off broadening its credit score criteria impacts millions of potential homebuyers.
The current credit score model is mostly dictated by Fair Isaac Corporation (FICO), and is calculated by each individual’s:
- payment history (35%);
- amounts owed (30%);
- length of credit history (15%);
- types of credit used (10%); and
- credit inquiries or new accounts opened (10%).
But this model leaves out a significant portion of the population who have non-traditional credit histories. In other words, these people don’t have credit cards or auto loans, but they do likely pay rent, have a cell phone plan or even check out materials at their local library. There is a small effort to include these nontraditional credit histories in the underwriting process, but it involves manual underwriting, which is time-consuming and avoided by many lenders.
The problem with credit scores
The higher an individual’s credit score, the more access they have to mortgage funds and other types of loans. Fannie Mae and Freddie Mac, the Federal Housing Administration (FHA) and the Veterans’ Administration (VA) all have minimum credit score requirements. Further, lenders use less-than-perfect credit scores to justify higher interest rates as a lower credit score is associated with higher risk.
For mortgage applicants who lack traditional credit, they are able to petition a lender to consider other evidence they will pay back their mortgage, including payments on:
- cell phones;
- tuition; and
However, in order to take advantage of positive payment history, landlords and creditors need to report these payments to credit reporting agencies. This process can be cumbersome and unreliable for applicants, making non-traditional credit difficult to actually use in scoring.
The FHFA, along with a team of experts and mortgage professionals, was considering how to more regularly integrate these types of non-traditional credit histories into credit scores. One popular option was to switch from using FICO scores to a different model, called VantageScore, which more seamlessly integrates non-traditional credit histories. They were expected to finalize their decision in 2018.
Now, the Act requires the FHFA to start over, shifting from choosing the best credit score model to developing their own model. The FHFA expects to complete the necessary steps by the end of 2020.
For now, credit score reporting remains the same, and access to mortgages remains limited.