Change May Be Afoot In Credit Scoring
Published Date 1/5/2018
Since the development of the FICO credit scoring model in 1989, lenders—including mortgage lenders—have relied on that method for assessing the creditworthiness of people applying for mortgages and other types of loans. The FICO Classic score, developed by Fair, Isaacs & Co., ranges between 300 and 850. Lenders require a minimum of 620 for conventional loans (those that will ultimately sell to Fannie Mae or Freddie Mac), while borrowers with scores as low as 580 may qualify for a loan insured by the Federal Housing Administration (FHA) with as little as 3.5% down.
The FICO Classic does have some drawbacks for consumers. The three credit reporting agencies, Experian, Equifax and TransUnion, have collaborated to develop a new scoring system, called VantageScore, which also generates scores between 300 and 850. The Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, is considering the use of this model. It has begun a comment period, which will be open until February 2018. Interested consumers can go to the FHFA’s Request for Information page.
Mortgage giants Fannie Mae and Freddie Mac currently own or guarantee half the mortgages in the United States.
VantageScore claims that the use of the new model will open the credit window to 7.6 million potential borrowers who do not qualify under the current FICO model. While the specific number may be debatable, there are enough differences between the two scoring systems to allow more people to qualify.
Both scoring systems use the same criteria to generate their scores:
- Payment history
- Length of credit
- Types of credit
- Credit usage
- Recent inquiries
The differences have to do with how the information from the borrowers’ credit files is processed. Some of the differences may benefit consumers whose credit files are comparatively unseasoned or “thin” (few active accounts).
Both methods consider “hard” inquiries for credit in generating their scores. Too many of them may lower a borrower’s score considerably. Because a consumer often shops around for financing, whether for consumer financing or a mortgage, FICO and Vantage perform “deduplication” of inquiries. This means that they consider multiple inquiries for the same purpose over a certain period to be the same as just one. For FICO, the deduplication period is 45 days. For Vantage, the time is shortened to just 14 days.
FICO requires at least six months’ history before issuing a score. Vantage would shorten that period to just one month. This is of particular interest to younger borrowers just beginning to establish credit.
FICO judges delinquent payments on all types of credit in essentially the same manner, while Vantage treats late payments on mortgages more harshly.
It is unlikely that there will be any changes to credit scoring in the immediate future, but it is important for consumers to be aware of the mechanism for any credit scoring system so that they can adjust their financial behavior accordingly.