If you want to buy a house and you need a mortgage to do it, your credit score matters. A lot. One score in particular – FICO – has long mattered the most. But that may soon change.
The Federal Housing Finance Agency this week announced a new rule that will open up competition for which score, or scores, Fannie Mae and Freddie Mac use to evaluate whether your credit is good enough to qualify for a mortgage.
The current one they use, the classic FICO or FICO Score 5, leaves tens of millions of people out — often people of color and people with low incomes, who maybe don’t have traditional forms of credit that FICO weighs most heavily.
The most high-profile contender vying for consideration is VantageScore, which is owned jointly by the three biggest credit-reporting firms, Equifax, TransUnion and Experian, and takes a different approach to calculating credit scores to FICO. FICO itself has newer scoring models that it could submit for consideration.
Either way, the FHFA says it wants to help more people access home loans.
“One of my priorities is to ensure that the American people have a safe and sound path to sustainable homeownership, which requires tools to accurately measure risk,” said Mark Calabria, the director of the FHFA. Calabria called the new rule “an important step toward achieving that goal.”
What’s wrong with the current FICO scoring system?
“From the perspective of consumer advocates, one of the problems is that it still counts medical debt against consumers,” said Chi Chi Wu, a lawyer with the National Consumer Law Center. That, she said, is the biggest reason the NCLC and other consumer advocacy groups have been pushing for years for Fannie and Freddie to move away from using FICO Score 5.
“Medical debt is actually a huge problem with credit reports,” Wu said. A significant percentage of the bills that go to collections, and end up damaging people’s credit reports, is unpaid medical bills.
“A lot of them are for things like co-pays and deductibles, $200, $500 medical debts,” said Wu. “And you know, there’s a good argument those really shouldn’t reflect credit worthiness.”
Newer scoring systems, from both FICO and from VantageScore, are said to dramatically reduce how much medical debt can negatively affect someone’s credit score. That, Wu said, will help consumers.
Another thing that could help consumers currently left out of traditional credit scoring models, she said, is the taking into account of new kinds of data, like rental payments, bank accounts and on-time payments for cell phone or cable bills.
What is the difference between the existing FICO scoring system and VantageScore?
Both FICO and VantageScore will only reveal so much about how, exactly, they calculate credit scores. They consider it proprietary information.
But VantageScore says its model could give 40 million more people — people who are currently “credit invisible” — a credit score.
“We believe that we have a credit scoring model that is very predictive and precise, and that we can score millions more people that today might not have a credit score,” said Phillip Bracken, managing director of VantageScore Solutions. Given that, he added, they believe their scoring model would “widen the window of opportunity for consumers in the mortgage marketplace.”
They do that by giving scores to people who have short credit histories, say less than six months, and to people who don’t have a recent credit history.
“A reasonably good share of those [people] might be mortgage-eligible right away,” said Bracken, referring to the VantageScore scoring model.
It’s not always better, though, to have a credit score than no score at all — particularly if the only things going into calculating that score are negative, such as bills that went to collections.
Joanne Gaskin, vice president of scores and analytics at FICO, said that, right now, if you look at the VantageScores for people who don’t have any FICO score at all, “more than two-thirds of them get a score below 620, which would effectively lock them out of the prime market.”
Wu, of the NCLC, agreed that VantageScore’s criteria might not always end up benefiting people who might otherwise have been credit invisible. “The number of folks that they actually score who end up with good credit scores that will qualify them for mortgages is a lot less than 40 million,” she said.
Is FICO updating its own scoring model?
Yes. FICO does have a variety of scoring models, beyond just the classic FICO or FICO Score 5 – though that’s currently still the one Fannie and Freddie use to evaluate someone’s mortgage eligibility.
Under the new FHFA rule, FICO will be able to submit one of its newer scoring models – maybe FICO Score XD, FICO Score 9 or UltraFICO – for consideration for use by Fannie and Freddie, too. And it plans to.
“We anticipate that we will apply to have our scores tested,” said Gaskin. “And we’re really excited about the opportunity to have them move to one of our more up-to-date scoring models. There’s certainly some benefit there in terms of greater accuracy.”
“The interesting thing is FICO has developed some of the more interesting newer products out there, for example, FIFO XD, and they’re coming out with UltraFICO,” said Wu, of the NCLC. Those rely on new data sources, such as bank account data, cell phone and cable data, or rental payments.
“So it’s interesting that there’s this argument, ‘oh, well, FICO is a monopoly, and they’re the only option out there,’” she said. “They’ve actually developed these new, interesting pilots of models that might bring more people into the system.”
When will the scoring model that Fannie and Freddie use actually change?
Chances are, not for at least two years. According to the FHFA, there is no set timeframe in place right now, but it estimates “based on years of related credit score work, that it will take the industry approximately 18-24 months to adopt a new credit score model after a model has been approved,” according to an online fact sheet.
Wu said she expects that it could be even longer, maybe between two and four years. That, she noted, is on top of the five years it’s already been since the NCLC first started urging the FHFA to require Fannie and Freddie to move to a newer, more updated model.
Changes like this, she said, are often “glacially slow.”
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