Are lenders or homebuyers playing it too safe with credit scores?
Note: This is part two of a two-part series on the widening gap between average consumer and homebuyer credit scores. Read part one.
The widening credit score gap between the average consumer and homebuyer reflects better consumer awareness of how credit scores work contrasted against growing uncertainty about what it takes to qualify for a mortgage that's keeping many would-be homeowners on the sidelines.
Credit experts point to a number of reasons to explain how the average consumer credit score has risen to new record highs.
In 2003, the Fair and Accurate Credit Transactions Act granted consumers the right to request and obtain their credit report from the three major credit bureaus once every 12 months, which helped consumers better understand and manage their credit. Even further, about five years ago, FICO's Open Access program gave consumers even more visibility into their credit profiles, as lenders were given the ability to provide customers with their FICO scores.
"We certainly would highlight the increased consumer awareness and the increased availability of FICO scores and credit education content as a driver of the [credit score] improvement that we've seen in the recent past," according to Ethan Dornhelm, vice president for scores and analytics at Fair Isaac Corp.
Like lenders, consumers are executing new approaches to credit post-crisis, which includes taking on less risk.
What's interesting is that in other consumer credit products, like education and auto lending, the borrowers are there. In fact, the subprime share of auto lending is back at peak from where it was during the crisis.
So while consumers seem to have an appetite for some products, the credit binge may be keeping them from feasting on mortgages.
"It's very interesting because most people diagnose that it's the supply side, and once I started to look at the application data about six or nine months ago, I became clearly convinced that it's a demand side issue," said Sam Khater, deputy chief economist at CoreLogic.
What consumers fail to realize is that a stricter process will only help them more safely obtain a loan, and their unwillingness to take on more risk has only been hurting them in the long run.
"I think it's a lost opportunity," said Khater. "We have had extremely low mortgage rates over the past few years and the fact that many lower credit borrowers are not participating in the mortgage market when mortgage rates are extremely low and when home prices are increasing 5% a year. In other words they'd have, if they had bought three or four years ago, 20% in equity."
Borrowers can't take all the blame.
The crisis was a wake-up call for consumers, and helped them manage their credit better. But, it also made them hesitant. What lenders have that borrowers lack is specialty in the subject and tactics to help them take on more risk. Now, more than ever, lenders have exposure to the proper tools to more responsibly take on risk, but not enough are.
The GSEs are encouraging lenders to lend to the full extent of their credit boxes with efforts like Fannie Mae's Day 1 Certainty initiative. And an even bigger opportunity for lenders lies in how they assess these lower-scored borrowers.
"You want to paint the whole picture of credit access when you're looking at credit scores," Joe Mellman, senior vice president and mortgage business leader at TransUnion, said when describing the importance of consulting trended data to determine the creditworthiness of a potential borrower.
"You want to paint the whole picture of credit access when you're looking at credit scores."
— Joe Mellman, senior vice president and mortgage business leader at TransUnion
With a credit score being just a snapshot of a moment in time, it will help determine the financial character of a borrower, but won't be able to demonstrate all behavioral patterns among other components, like assets, income and employment.
"I think the way that you look at that information doesn't have to necessarily be the legacy credit score that the industry has been using for the years that it's been in place," said Mellman.
In terms of mortgage access, lenders shouldn't be looking at anything in isolation in 2018. Though credit is an important aspect in determining the financial character of borrowers and their ability to pay, it's not enough to fully capture them.
"You can't just lend on a credit score because it is reflective of past behavior. You have to look at the whole borrower and that's where data aggregation comes in. Ten years ago, we had much more limited ability to collect all of these other little data sets that you need to get a really three dimensional picture of the borrower," said Ann Fulmer, chief strategy and industry relations manager at FormFree Holdings Corp.
The credit score gap between average consumers and homebuyers was much tighter in the past because the pool of borrowers possessed a broader range of scores, particularly on the lower end of the spectrum, according to Jeff Bode, president and CEO of Mid America Mortgage.
"I don't think the gap is necessarily a bad thing," he said. "From my perspective, the difference in the FICO scores between 10 years ago and now is largely due to the poor quality of loans that were originated prior to the housing crisis."
"Foreclosures and bankruptcies can impact a consumer's credit score for years, and we're only a decade removed from the height of the crisis so we may see scores trend upward," he added.
Another tool lenders can ultimately benefit from is the recent removal of liens and judgments from consumer profiles. Though this may require an extra step in verification, third-party applications assist in fact-checking, which may help approve more applicants in the end.
Lenders can also capitalize on alternative loan programs to help a wider range of borrowers get through the door. Currently, only about 20% to 25% of the housing market is really starting to understand and adopt these programs, which provide tools for lower credit borrowers, those with limited access to credit, and buyers not able to put a significant amount of money toward a down payment.
"As these programs become more popular and mainstream, you're going to have a lot of borrowers that were with lower FICO scores getting in the market. You're going to see that gap not increase, but reverse basically," said Raymond Eshaghian, president and CEO of Greenbox Loans.
To tighten this broadening gap between scores and safely taking on more risk, two things need to happen: borrowers need to enter the market and lenders need to show them how.
Communication is key and that falls on lenders. For borrowers hesitant to enter the housing market, lenders need to educate them on how and why they can. And for consumers disinclined to apply, lenders can illustrate their options. Financial literacy and outreach from lenders become top priorities in reconditioning a fallen pool of borrowers back into the marketplace.
"I think today we're in a better risk management space in terms of looking at the full view of credit than we were 10 years ago, and we're not taking advantage of that," said Khater.
"It would behoove lenders to more clearly communicate that if you're a 700 credit score borrower, for example, you can get a loan. Those with 700 credit scores are not applying. I think part of it is that it's a communication problem."