Are lenders’ credit-score requirements for home purchasers this spring too high – out of sync with the actual risks of default presented by today’s borrowers? The experts say yes.
What experts? The developers of the credit scores used by virtually all mortgage lenders. Executives at both FICO, creator of the dominant credit score used in the mortgage industry, and up-and-coming competitor VantageScore Solutions confirmed to me last week that mortgage lenders could reduce today’s historically high score requirements without raising their risks of loss. In the process, many prospective buyers who currently can’t qualify might get a shot at a loan approval.
Consider this: Consumer behavior in handling credit is subject to change over time, often keyed to regional or national economic conditions. Credit scores that were acceptable risks in the early 2000s – say FICOs in the 640 to 680 range – turned into larger than anticipated losers when the recession hit. Now that the housing rebound is well underway and federal regulators have imposed tighter standards on income verification and debt ratios, the high credit score “cutoffs” that virtually all mortgage lenders imposed in the scary aftermath of the crash are stricter than necessary.
FICO scores run from 300 to 850. Lower-risk borrowers have high scores, higher-risk consumers low scores. Early in the last decade, a FICO score of 700 was considered good enough for an applicant to get a lender’s best deals or close to it. Today a 700 FICO just barely makes the grade – 50-plus points below the average score for home purchase loans at Fannie Mae and Freddie Mac, the big investors.
In an interview, Joanne Gaskin, senior director of scores and analytics for FICO, said that statistical studies by her company have demonstrated that “the risk of default on more recent mortgage vintages is better than at the onset of recession” – essentially real risk has reverted back to the early 2000s.
To illustrate how consumer behavior has improved, Gaskin cited one internal study that examined mortgage default data through 2011. At a FICO score level of 700 in 2005, roughly 36 borrowers paid their loans on time for every one who went into serious default. In 2011, by contrast, for every one defaulting mortgage borrower, roughly 91 paid on time. That’s a huge decrease in risk to the lender.