When President Trump signed legislation that “rolls back crippling Dodd-Frank regulations” on banks, as he described it in May, he also kicked off a revamp of the way credit scores are used in approving home loans.
The measure was one of several smaller bills crammed into the bipartisan legislative package to help win the support of individual senators, thus becoming law without much too much notice. It is now poised to have a significant impact on prospective homebuyers and the housing industry.
Advanced by Sen. Tim Scott, R-S.C., and a group of Democrats, the measure mandates a rethinking of the use of credit scores by the bailed-out government-sponsored mortgage enterprises, Fannie Mae and Freddie Mac, and their government caretaker, the Federal Housing Finance Agency.
Under the law, Fannie and Freddie will be required to consider using new or updated credit scores for their mortgage approval process, in addition to the FICO scores they use today.
From Scott’s point of view, the point would be to allow home lenders to take a closer look at potential borrowers who, today, don’t meet the minimum eligibility requirements because they don’t have a credit score.
The workings of Fannie and Freddie are hugely influential in the broader housing market.
Fannie and Freddie don’t directly make home loans, but they inject more money into the system by purchasing mortgages from banks and other lenders, and packaging them into securities to sell to investors.
Together, they back about $5 trillion in mortgage-backed securities, and the loans they purchase count for nearly half of all new home loans. As a result, the standards they set for loans they buy have a major effect on housing markets. And because they remain in government hands 10 years after failing, decisions about those standards are up to the government.
By changing the credit scores that Fannie and Freddie use, the thinking goes, a lot more people who are rated uncreditworthy today may be able to get home loans.
“Those who are ‘credit invisible’ oftentimes miss dreams and opportunities associated with homeownership or starting a small business despite the fact that they are creditworthy,” Scott said. “Using a scale for mortgage credit that includes payments for rent, utilities, and cell phones opens up countless possibilities for working Americans that work hard, pay their bills on time, and play by the rules.”
There are about 26 million who are credit invisible in the sense that they have no credit history, according to the Consumer Financial Protection Bureau, and another 19 million with “stale” credit, meaning that they don’t have enough recent credit history to be used by credit scorers.
To have a FICO score, a borrower has to have a credit account open for at least six months. That is the cutoff that FICO has determined actually provides a signal about borrowers’ trustworthiness.
But there are alternatives. The leading alternative, which all parties think may be positioned to take advantage of the new law, is VantageScore, a twelve-year-old credit-scoring model that is a joint venture of the three major credit reporting bureaus: Equifax, Experian, and TransUnion.
A VantageScore, like a FICO score, is based on credit reports. The biggest difference between VantageScore and FICO is that the VantageScore will create a score with less than six months of data. Fannie and Freddie using VantageScore as part of their underwriting could make a lot more people eligible for home loans.
VantageScore sees the law as a potential opening to compete with FICO for mortgages as they do in other markets, such as auto finance.
“We expect an end to FICO’s government sanctioned monopoly because it suppresses competition,” said Barrett Burns, CEO of VantageScore.
Liberal Democrats, as well as FICO, are resistant to that prospect, and not just because it would be a win for Equifax, a firm in political disfavor since the news last year that it suffered a breach that exposed the personal data of about half the country.
“VantageScore is owned and controlled by the three major credit bureaus, which are the single point of sale and distribution for both credit reports and scores,” said Joanne Gaskin, FICO’s senior director for Scores and Analytics. “Allowing the credit bureaus to offer VantageScore in this new process will not increase competition, it will consolidate their power at consumers’ expense.”
The fear, Gaskin explained, is that the bureaus could lower the price of VantageScore scores to undercut competition, and then make up the difference with more sales of credit reports. In that way, by trying to boost volume of sales, they’d be pressured to lower standards to drum up more business, making the housing system riskier.
It’s a fear shared by Mel Watt, the Obama-appointed director of the FHFA.
“Credit scoring is one of those things where competition is good if you’re competing on the right things,” Watt said in congressional testimony in May as the bill was passing. “But if you’re competing just to get more business in the credit scoring arena, that’s not a good thing.”
The FHFA declined to provide further comment, as did Fannie and Freddie.
Burns argued that the claims that VantageScore would have too much pricing power if brought into Fannie and Freddie’s models was “a smokescreen for those who prefer the status quo,” noting that each bureau sells VantageScores separately, not in collusion, and federal regulations prohibit price fixing.
In fact, the legislators’ intent was not to kick off a battle between FICO and VantageScore. Including rent and utility payments in the score calculation, as Scott called for, would be a much bigger change still.
The CFPB, in the past, has also expressed interest in using regular non-credit payments in credit scores. Last year, while still under the direction of Obama appointee Richard Cordray, the agency asked the public for feedback on incorporating such payment scores.
But for the foreseeable future, FICO vs. VantageScore will be the battle to watch. The credit bureaus, in particular, are major lobbying forces on the Hill.
Watt suggested that it could be two years before his agency, which was already in the process of soliciting information about the use of credit scores, would reach a determination about updating standards for credit scores. It will be a lengthy battle.