In less than a month, the nation’s top credit-reporting agencies (CRAs) will drop most civil judgment and tax lien data from consumer credit reports. It’s a change that will boost millions of consumers’ credit scores – and one that raises major concerns for employers, landlords, mortgage bankers, and other lenders and service providers that use FICO scores as a primary means of determining consumer creditworthiness.
Starting July 1, Equifax, Experian and TransUnion will remove from credit reports debt records that cannot be “triangulated” with a consumer’s 1) full name; 2) complete address; and 3) Social Security number or date of birth.
According to LexisNexis Risk Solutions, about half of tax liens and 96% of civil judgment records don’t include enough information to meet these criteria, often because the consumer’s Social Security number is redacted from court records for privacy purposes. Even when records do contain enough personal information for the CRAs to confidently assign a lien or judgment to a consumer’s credit report, the agencies will have to check public court records for any updates (for example, discharge of the debt) at least every 90 days or remove these debts, too.
The new policy is part of a National Consumer Assistance Plan developed by all three CRAs in a 2015 settlement with multiple state attorneys general. The change may also help the CRAs address a March Consumer Financial Protection Bureau (CFPB) report that challenged the accuracy of credit reports following the bureau’s receipt of more than 190,000 credit reporting-related complaints. Both the CFPB report and a multiyear investigation by 31 state attorney general offices called into question the ability of credit agencies and other aggregators of public-records data to keep financial information up to date and accurately match it to the correct consumer.
Millions of consumers affected
According to the Consumer Data Industry Association, around 12 million people will see tax liens and civil judgments drop off their credit reports next month. Most will see their credit scores rise by 20 points or less, but around 700,000 consumers are expected to see up to a 40-point improvement in their FICO scores. Bankrate has calculated that these adjustments may bump the average American credit score above the 700 mark – the approximate threshold for a “good” rating – for the first time in history.
Although the new policy will only immediately affect an estimated 6% of credit reports, it will strictly curtail the number of future liens and judgments reported, artificially inflating the scores of countless future consumers.
What it means for lenders
The change will also make loan screening more difficult for lenders, most of which rely on one or more of the major CRAs to tell them if prospective borrowers owe or have recently owed a tax lien or civil judgment. This information is a critical part of how underwriters assess the character and debt capacity of consumers, which is why most secondary market investors – including government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac – want lien and judgment data included with every loan file.
For the most part, the GSEs will not even purchase conventional loans unless all tax liens and civil judgments owed by the borrower are verified as paid in full because ensuring such debts have been satisfied helps protect the investor’s lien position. The guidelines are a bit more lenient for Federal Housing Administration loans, which investors will generally purchase as long as any liens or judgments are subject to repayment on an installment plan. In these cases, underwriters need lien and judgment data to verify satisfactory payment history and account for the remaining installment payments when calculating a borrower’s ability to repay under ability-to-repay/qualified mortgage (ATR/QM) rules.
Additionally, a history of tax liens or civil judgments – even if they’ve been paid off – may indicate whether a borrower is likely to pay future financial obligations. This supposition explains why CRAs have long factored liens and judgments into their FICO scoring models and was recently confirmed by a LexisNexis study that found people with liens or judgments are twice as likely to default on a loan.
Speaking of FICO scores, recall that nearly 12 million of them will increase by up to 40 points with this change. That means some borrowers whose scores are too low to qualify for a given loan today may suddenly find themselves elevated into the “acceptable” range after July 1, even though nothing will be materially different about their creditworthiness. If that sounds arbitrary and unfair to you, you’re not alone; the anticipated change is causing many people to question the validity of FICO scores altogether.
A path forward
Lenders must find an alternative source of lien and judgment data following the July 1 change; otherwise, they won’t be able to represent and warrant that their loans meet investor guidelines – meaning they won’t be able to sell them on the secondary market.
Some mortgage originators may be tempted to rely on title search as an alternative source of the required lien and judgment data, but title reports are a poor substitute for the information currently found in consumer credit reports. It’s true that tax liens show up fairly reliably during title search, but reporting of civil judgments is much less consistent. That’s a serious drawback, given that real estate can be sold to satisfy a judgment.
Whereas credit reports are ordered at the front end of the loan application process, title searches are typically ordered late in the origination process, after the loan has been approved. Consequently, lenders increase their risk of fallout and stand to lose a significant amount of money whenever a title search turns up an outstanding tax lien or civil judgment.
At the very least, liens and judgments that surface late in the game mean serious disruptions and delays in getting the loan to closing. If the liens can’t be cleared and the closing falls through entirely, lenders will have wasted all the time and effort invested by the loan officer, processor and underwriter – not to mention the cost of the title report and other direct loan expenses. Worse, they will have delivered the kind of poor customer experience that leaves a bad taste in the mouths of everyone involved in the transaction and puts lenders’ reputations at risk.
Another possible solution is to get a direct feed of lien and judgment data from a provider such as LexisNexis, whose database of 40 billion records identifies multiple points of consumer and property information to match debts to borrowers with a high degree of certainty. This search should be performed at the front of the origination process so that debts can be identified and dealt with early on.
Although lien and judgment data can be purchased directly from LexisNexis, lenders are likely to find that going through a best-of-breed automated verification vendor that’s already integrated with their loan origination system and vetted by GSE initiatives such as Fannie Mae’s Day 1 Certainty enhances efficiency and further reduces risk.
The route lenders choose to address the July 1 change is open for debate, but the need to find a solution is not. Loan files that don’t include lien and judgment data will not meet investor guidelines, causing serious headaches for lenders. On a larger scale, ignoring tax liens and civil judgments puts consumers in danger of signing up for loans they don’t actually have the ability to repay – a violation of the ATR/QM rules that could reduce the value of the loan and expose lenders to unwanted attention from the CFPB.
It already costs an average of more than $7,000 and 40 days to take a loan from application to closing. The last thing lenders need is for a mid-summer lien and judgment reset to set them back on critical performance and profitability benchmarks. The good news is that there’s no need for lenders to sweat it this July. Instead, they can swap out credit bureau data for automated verification of liens and judgments to greatly reduce loan cost and time to close while more accurately linking debts with debtors.
Ann Fulmer is loan quality subject matter expert and analyst who recently joined asset verification solutions provider FormFree as chief strategy and industry relations officer. A nationally recognized strategist, thought leader, speaker and author specializing in data integrity, fraud and federal/Consumer Financial Protection Bureau regulatory compliance in mortgage loan originations, Fulmer has been a mortgage industry mainstay for more than 17 years.