It can’t just be about the credit score anymore. Traditional credit reports provided by the national credit bureaus have long been, and should remain, a primary tool for mortgage lenders in determining borrower risk. However, evaluating post-financial crisis creditworthiness, including the ability to repay, is more complicated in today’s market. Caught off-guard by the crisis, lenders, servicers and borrowers alike experienced the snowballing effects of the collapse: job loss, mortgage delinquencies and foreclosures. In many cases, mortgage defaults were circumstance-driven, not a reflection of a borrowers’ willingness to repay their debts, and likewise, those circumstances might change again as the economy continues to recover.
Consider the following scenario: John, a contractor in Las Vegas, had a six-figure salary until the market collapse. After losing his job, John fell behind on his mortgage payments and eventually lost his house through foreclosure. Today, John has his six-figure salary back as the housing recovery in Las Vegas accelerates rapidly. Or imagine another scenario where Jane could not keep up with her mortgage payments because she faced staggering health care bills and her husband worked part-time after having lost his full-time job. Now, Jane is healthy, has returned to work and her husband has been working full-time for the past two years. Is either borrower now a safe bet for a lender?
Lenders are left trying to answer a difficult question about these applicants: How do you know if a potential borrower with a low credit score really is a high risk? There are many borrowers whose credit scores have suffered, but are nevertheless in a solid position to demonstrate the willingness and ability to meet their obligations. And servicers similarly wonder how loan performance can be better understood years after origination. One way to help answer those questions is through the use of supplemental FCRA-compliant credit data at the time of origination and for ongoing borrower-risk assessments during the servicing cycle.
In the early 2000s, when lenders typically only looked at an individual’s FICO score to understand an applicant’s credit history, non-GSE lending decisions were simpler, and single, point-in-time assessments at origination were considered a reliable tool. The economic collapse demonstrated that while FICO scores were reliable, over-reliance on them to make lending decisions was a key contributor to the crisis. Now, there are more pieces to the credit puzzle. By taking a look at average credit risk scores by loan originations over the past decade, the reality that lenders have become more risk averse since the collapse in 2008 is more clearly illustrated.
In January 2003, for example, about 19% of loans originated were below a 640 FICO score while 68% fell into the 640-779 bracket. Fast forward a few years to January 2006 and a slight shift starts to become visible, with nearly 24% of loans originated at below a 640 FICO score and 63% falling into the 640-779 bracket.
Then there’s today, when the 640-and-under FICO score group has all but disappeared. As of January 2013, a mere 2.5% of all loans originated were 640-and-under, while 72% were in the 640-779 range, and an even more impressive 25% of loans went to borrowers with FICO scores of 780 and above.
In the current market, consumers with FICO scores lower than 640 are considered risks that not many lenders are willing to take. But with the right information, and a more detailed picture of each potential borrower’s personal credit history, lenders might find not all of those consumers are quite as high risk as their traditional FICO scores would suggest—and as a result, they can gain a competitive edge by tapping into a pool of underserved, creditworthy borrowers.
Revisiting the John and Jane examples, how does a lender determine their risk in the post-downturn world? Similarly, how does a servicer, several years later, determine how their credit worthiness may be evolving?
Unfortunately, because the housing market collapse was unprecedented in its scope, there are no relevant historical behavioral trends from which to predict how people who were affected by but are now recovering from the collapse will behave. It’s also safe to assume that people like John and Jane have a traditional FICO score below 640.
Therefore, traditional credit scores aren’t telling the full story of each prospective borrower. Because they can be inadequate, more and more lenders should be turning to supplemental FCRA-compliant data to paint a more accurate picture.
Supplemental credit data includes records such as landlord/tenant data, property transactions, public records and other credit information not included in the standard credit score. Moreover, the combination of consumer data with property data can often uncover previously unknown assets or debt.
A recent study conducted by CoreLogic on behalf of a top mortgage lender corroborates this finding. It discovered $68 million in undisclosed mortgage debt after analyzing 3,481 funded loans. This type of supplemental data can have a positive impact on a consumer’s credit profile if they show consistent, on time payment behavior.
As a result, leveraging supplemental FCRA data as either a pre-funding evaluation tool, or during regular portfolio reviews, can show that a 620 FICO score consumer might actually behave more like a consumer with a FICO score in the 700 range. A recent CoreLogic analysis of a new FICO score that takes supplemental data into account proves this out. Over 24% of the files analyzed showed a score improvement of over 50 points when supplemental FCRA data is factored in.
Knowing which individuals were considered creditworthy prior to the recent, unprecedented economic crisis and taking the extra step to understand their current circumstances can offer lenders a solid foundation from which to assess a borrower’s true current risk.