The Federal Housing Finance Agency is seeking the opinion of mortgage lenders, professionals, and relevant housing stakeholders regarding Fannie Mae and Freddie Mac’s update on their credit score requirements.
This update entails a shift in the use of Classic FICO scores to another scoring model/s when making loans deliverable to Fannie or Freddie.
As to what the replacement credit score/s are, and the impact these new credit score requirements will bring, is the subject of a request for input filed by FHFA.
How Fannie, Freddie Use Credit Score
Fannie and Freddie Mac previously only allow the use of Classic FICO scores to underwrite loans. But further updates to their automated underwriting systems (AUS) enabled borrowers without this type of credit scores to be reviewed for approval.
Credit scores start with CRAs — Equifax, Experian and Transunion — that collect data on each consumer and compile their own credit report and score. These credit reporting agencies combine these individual reports and credit scores (three of them) in one tri-merge credit report.
Lenders will review this tri-merge credit report and use it when making a decision on a loan application. If they intend to sell the loan to Fannie Mae and Freddie Mac, the loan must meet the Enterprises’ standards.
These standards include minimum credit scores and manual underwriting guidelines for those without scores. Fannie and Freddie use these scores to price the loan and determine the overall mortgage eligibility.
The Enterprises will buy the loan conforming to their standards and pool it along with other mortgages.
These mortgage-backed securities are sold to investors who rely on credit scores to measure the risk of securities bought from the Enterprises.
Lenders sometimes require mortgage insurance because of small down payments. MI protects both the lender and Fannie or Freddie in the event the borrower defaults on his/her loan. MI rates depend on the actual loan-to-value ratio, mortgage type, and credit score.
Assessment, Replacement of Credit Score Requirements
As part of their 2015 and 2016 scorecards, the Enterprises reviewed commercial credit scoring models used by the CRAs. Their analysis focused on:
- Classic FICO: The Enterprises have used this model for more than 12 years, consisting of (i) FICO 5 from Equifax Beacon®, (ii) TransUnion FICO® Risk Score Classic 04, and (iii) Experian®/Fair Isaac Risk Model V2SM.
- FICO 9: It uses data reported to the three CRAs to generate a credit score.
- VantageScore 3.0: Is based on data from the CRAs to create a credit score.
FHFA and the Enterprises believe that while Classic FICO “remains a reasonable predictor of default risk”, the following reasons favor a shift to a new scoring model:
- New credit score models display a higher accuracy in predicting default risk.
- FICO 9 and VantageScore 3.0 have been updated to reflect economic changes since the financial crisis.
- Paid-off third-party collections don’t negatively affect borrowers in new credit score models.
- New credit score models treat medical collections differently resulting in a less negative impact on borrowers.
- Rental history is included in new credit score models.
Against this backdrop, they are currently reviewing these credit scoring options for use in making agency loans:
- First option involves using one score, FICO 9 or VantageScore 3.0.
- Second option requires both credit scores.
- Third option allows lenders to deliver loans with FICO 9 or VantageScore 3.0, whichever is available.
- Fourth option allows lenders to deliver loans with multiple scores via a waterfall approach.
FHFA recognized that any update to the Enterprises’ credit score requirements will bring about industry-changes that could result in higher borrowing costs for consumers.
For this reason, the agency wants to hear from parties who may be affected by this transition to another scoring model, on or before 20 February 2018.
It will take 12 to 18 months for the Enterprises to implement a new credit score. Any new credit score rollout will likely begin upon the full implementation of the Common Securitization Platform and Single Security Initiative in 2019.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.