The Federal Housing Finance Agency (FHFA) is officially postponing the decision on changing the credit scoring models Fannie Mae and Freddie Mac (government-sponsored enterprises) have used since the 1990’s. FHFA was established by the Housing and Economic Recovery Act (HERA) of 2008 to regulate and supervise Fannie, Freddie, and the Federal Home Loan Bank System. Tackling the complex issue of switching the current credit scoring model used by Fannie and Freddie has been front and center for almost two years. A final decision was expected by the end of 2018 but all that has changed now.
FHFA announced in a news release July 22, 2018 that they will stop their credit score initiative and instead, “is shifting its focus to implementation of Section 310 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (Public Law 115-174) enacted in May (the Act). The Act requires FHFA to define, through rulemaking, the standards and criteria the Enterprises will use to validate credit score models.”
According to an FHFA news release, the credit score initiative focused on “evaluating the potential impact of a new credit score model or models on access to credit, safety and soundness, operations in the mortgage finance industry, and competition in the credit score market for some time as part of an ongoing Conservatorship Scorecard Initiative.”
Banks vs Nonbanks
The ongoing use of the FICO credit score model has created an increasingly aggressive protest by nonbank lenders who feel it shuts the door on many potential homebuyers in the United States.
The position of the nonbank lenders is explained in a January 3, 2018, Wall Street Journal. “Many nonbank lenders, which in some recent quarters have accounted for more than half of the mortgage dollars issued in the U.S., want the ability to use a credit score provided by a company owned by credit-reporting firms Equifax Inc., Experian PLC, and TransUnion. These lenders argue the alternative score would open the mortgage market to a greater number of people and lead to more mortgage approvals, helping to boost home sales and the economy.” The company owned by the three credit-reporting firms is VantageScore, and it has an alternative credit scoring model.
Two Credit Scoring Models
The most significant difference between the two credit scoring models lands on how they evaluate individuals with little or no credit history. FICO requires six-months of reporting of credit to generate a score. VantageScore can create a credit score after one month of usage. FICO also penalizes all late payments in the same way, while VantageScore gives mortgage late payments more impact that late payments on other credit. There are subtle distinctions in how the two models treat collections, judgments, and liens as well.
However, when consumers are shopping for credit (auto loans, student loans, and mortgage loans), FICO combines inquiries from creditors within a 45 day period into one inquiry, thereby lessening the impact on your credit score. VantageScore shortens that period to 14 days, which significantly limits consumers ability to shop for and compare competitive credit offers.
For comparison, the impact of specific components of your credit history is weighted differently with VantageScore versus FICO. VantageScore breaks it down with:
- Payment history about 40%
- Age and type of credit about 21%
- Credit utilization about 20%
- Balances about 11%
- Recent credit about 5%
- Available credit about 3%
While Fico breaks it down with:
- Payment history: 35%
- Amounts owed: 30%
- Length of credit history: 15%
- New credit: 10%
- Other factors, such as types of credit used: 10%
The other side of the debate expresses concerns that opening up credit scoring to include those on the margins by current standards would create a bigger pool of borrowers for all lenders at the risk of sound lending practices. Mel Watt, the current head of the FHFA, questioned if it was as a possible “race to the bottom” of borrowers, in his remarks last year at the Mortgage Bankers Association’s Annual Convention and Expo. He also stated, “the more we looked into this issue, the more complicated it became, and it is turning out to be among the most complicated decisions I have faced during my tenure at FHFA.”
Now that the FHFA has ‘put a pin’ in the credit score initiative (until late 2020), the company behind FICO scores (Fair Isaac Company) will continue to enjoy a monopoly for the time being. While the FHFA focuses on compliance with Section 310 of the new law, the pressure will continue to mount from the nonbank community, and the debate will continue. Most parties agree that, in the end, there will be a change.