Settling The (FICO) Score


The FICO score may no longer be as important as it once was in the mortgage application and underwriting process, as evidenced by recent statements made by a leading marketplace lender, government-sponsored enterprise (GSE) Fannie Mae and members of the U.S. House of Representatives. Meanwhile, others in the mortgage business say that although FICO, which has been available since 1991, could use some updates to accommodate certain borrowers, it might be too soon to dismiss the measure by Fair Isaac Corp.

In January, marketplace lender SoFi announced that it had become a “FICO-free zone.” The online mortgage, student loan and personal loan lender says it no longer factors FICO in the loan qualification process. Instead, San Francisco-based SoFi uses employment history, track record of meeting financial obligations and monthly cashflow minus expenses.

In its announcement, the marketplace lender cited a recent Bankrate survey that found that 63% of millennials aged 18 to 29 don’t have a credit card, “showing that credit scores are becoming less relevant for this generation.”

There has been conversation in the industry about moving away from FICO because the system disenfranchises a significant portion of potential borrowers, says Stanley Street, president of Street Resource Group in Atlanta. “There are millions of well-qualified borrowers who basically are outside of the credit reporting system,” he says.

Still, larger lenders continue to use FICO. “The traditional mortgage market, with the traditional secondary market, as well as portfolio bank lenders, still relies very heavily on FICO scores,” Street says. “The marketplace lenders are now incorporating alternative algorithms to determine the creditworthiness of a borrower, but the loans they are originating … are not going into the traditional secondary market.”

That might change. A bill in the House of Representatives, H.R.4211, “Credit Score Competition Act of 2015,” would allow Fannie Mae and Freddie Mac to use other credit scoring models besides FICO. The bill is currently in the House Committee on Financial Services. Even if the bill passes, Street says, it will take a long time for the GSEs to change. “Until we develop a true secondary market that’s not GSE-bound, there won’t be any change,” he says. “I think that the marketplace lenders are disruptive, and there will be some displacement, but it won’t be major for years to come.”

Others say rather than changing the borrowing profile paradigm, it is better to wait for these consumers to become creditworthy.

Brian Biglin, chief risk officer for Foothill Ranch, Calif.-based marketplace lender loanDepot, says other marketplace lenders’ announcements about dropping FICO are a marketing ploy. “During economically favorable times, lenders start to compete, and they invest millions of dollars to attract customers,” he says. “Customers have choices, and lenders reinvent the mousetrap, and one of the ways to do that is by increasing approval rates.”

loanDepot uses FICO because, as Biglin says, it is good risk management. He does not agree with the strategy of ignoring FICO to qualify borrowers with limited credit history, as the goal should be to get inexperienced borrowers to build a solid credit history. “Everybody starts equally – that’s the great thing,” he says. “They should build up with credit cards, an auto loan and establish this credit history. Then, they can borrow a couple hundred thousand dollars.”

Becky Walzak, president and CEO of rjbWalzak Consulting in Deerfield Beach, Fla., says the use of FICO scores was driven by the secondary market, and any change will be gradual. “I don’t think people are going to wake up and say, ‘We are no longer using credit scores,’” she says. “The people that are creating the credit scores will come back and say, ‘We’ve changed our model, and it’s more predictive.’”

The need for these new models is being partly driven by millennials. “The trend seems to be [that] millennials are starting to move out of their parents’ homes now and are trying to buy,” Walzak explains. “They have limited credit, so their scores are lower, and they are really starting to impact those borrowers coming in the door.”

Some changes are under way. Last year, Fannie Mae announced that beginning in mid-2016, the GSE will require lenders to use trended credit data when underwriting single-family borrowers through Desktop Underwriter. Current credit reports indicate the outstanding balance and whether a borrower has been on time or delinquent with payments on credit cards, mortgages or student loans. The new trended credit data will give lenders access to the monthly payment amounts that the consumer made over time and show whether the borrower tends to pay off revolving credit lines or carry a balance month-to-month. Also, Fannie Mae said it will provide new functionality to Desktop Underwriter so that lenders can more efficiently serve borrowers who do not have a traditional credit history.

There already are alternative credit reporting systems, says Ellen Seidman, a senior fellow at the Urban Institute in Washington, D.C. “They are anything but the only ones around,” she says of FICO. One alternative is VantageScore Solutions, which last year offered a presentation, “Credit Scoring: Going Beyond the Usual,” at an Urban Institute event. According to VantageScore, of the 308 million people in the U.S., 227 million are in the credit-eligible universe, but only 180 million have conventional scoring files because they have credit files with a credit bureau. Of those consumers, 160 million have “thick” files, with three or more credit files, and 20 million have “thin” files, with one credit file. The 47 million who are not credit-scorable have infrequent accounts, accounts that are less than six months old or credit files that have not been updated in more than six months.

Seidman points out that many unscorable consumers pay rent and utility bills and have checking accounts with their paychecks direct deposited. Alternative scoring methods should consider these variables and others. For example, payday lenders are not included in FICO scores, but Seidman notes that if a borrower can pay off a payday loan with notoriously high interest rates, the person can likely pay off a loan with more reasonable terms. There has also been talk about using ZIP codes and even social media measures, such as how many Facebook friends a person has.

For its part, San Jose, Calif.-based FICO is piloting a new score, FICO XD, which incorporates data from the National Consumer Telecom & Utilities Exchange, including information on whether people pay their cable TV, utility and other bills. “It appears to work quite well,” says Dave Shellenberger, senior director of scoring and predictive analytics for FICO. “In our analysis, consumers that score high with FICO XD score 620 or higher, and two years down the road, we see the vast majority of these either maintained that score or migrated to higher scores.”

He says FICO is constantly looking for ways to innovate and respond to lenders’ needs. “This innovation is being driven by our clients. If you look at the industry seven or eight years ago, there wasn’t a huge amount of interest in tools that would help better assess these traditional under-banked individuals. There has been a shift in demand.”

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