What the FHFA credit score change could mean for the industry

Mortgage experts generally expect government-related investors' plan to replace FICO's "classic" score with newer ones — and more flexible credit reporting — could open up lending, but some are worried about unintended consequences and costs.

As the Federal Housing Finance Agency noted in announcing the plan, incorporating alternative data in scores and providing more flexible reporting could help more consumers qualify, but some fear it won't help everyone.

Some of the advances in the past decade not incorporated in the nearly 20-year-old classic FICO score or traditional reporting, like trended data, "could be advantageous to people who are working to reestablish credit," said Shmuel Shayowitz, president and chief lending officer of Approved Funding. However, he questioned whether they'll be as much help to younger people who lack payment track records.

Experts also think the multiyear initiative could require the mortgage industry to pay for the change.

Mortgages have long largely relied on a system in which one score and a tri-merge credit report have been used by the government-sponsored enterprises who buy many mortgages in the U.S., so the switch could require investment in the operational change needed to accommodate it.

The development is "a slight negative for the lenders, mortgage insurers, and other stakeholders/investors in the mortgage ecosystem that will have to cover the cost of this new policy," Ivan Boltansky and Eric Hagen, analysts at BTIG, said in a report.

"I think this move will make it more costly for mortgage applicants and mortgage originators to process loans," Shayowitz said, noting that his take is only a surface impression of the announcement's implications based on the information available to date.  

"Time will tell whether this is truly of benefit to the consumer," he said. (Mortgage companies often pass along increased costs to borrowers.)

However, others are more optimistic that those lacking payment histories and thin-credit borrowers will see lower costs due to what FHFA has acknowledged will be long-term score and reporting changes.

"This is a positive win, especially for low- and middle-income communities," said Daniel Smith, CEO and founder of Keepingly, a technology company that provides a home budgeting platform.

A reduction in consumer costs related to the credit reporting and scoring changes will materialize, but not right away, said Jonathan Lawless, director of homeownership at Bilt, and a former vice president for product development and affordable housing at one of the two government-sponsored enterprises the FHFA oversees.

"With this change, a positive rental history will impact mortgage pricing and the buying power of renters, meaning renters who previously had a low or no credit score will no longer have to pay a higher rate in this challenging rate environment," Lawless said.

"That said, changes to credit scoring will take time — potentially even years to implement," he added. "We hope that interim solutions, like how the GSEs leverage rental data already in underwriting, can help renters get a better rate today."

What happens with vendors during the time it takes to get the new credit system set up may determine what the net change in costs will be like for lenders. Vendors say they won't know that until the FHFA lays out more details related to the change, something mortgage and banking trade groups have sought as well.

Potentially, the planned reduction in credit reports could help offset a requirement to get the results from two scores rather than one, if that's the path the FHFA is headed down. The FHFA does have a track record of trying to balance cost fluctuations, as it has in its more immediate move to lower prices for some affordability loans while increasing them for cash-out refinances.

The credit scoring change will also affect the continuity of servicers' loan performance track records, given the underwriting criteria involved will change to a degree.

Score vendors generally aim to ensure that the scale and degree of risk that corresponds to each number remains consistent or improves in an updated model, potentially pulling in more borrowers on a net basis as they do so.

"FHFA's action will enable millions more creditworthy Americans to have access to mortgages by using VantageScore's more predictive credit score," Silvio Tavares, president and CEO of VantageScore, said in a press statement.

The use of an updated score could result in improved loan performance or expanded origination potential, according to Joanne Gaskin, vice president of scores and analytics at FICO, who indicated that the decision to include both scores rather than one in the update came as a surprise.

"Whilst we didn't expect a two-score decision, we're pleased that FICO Score 10 T is included. We think that it is the most predictive score out there, and by using it you can underwrite more mortgages without taking on any additional risk," she said. "What we've seen is an increase of about 5% in origination volume or a reduction of 17% in delinquencies using the newer model."

Some lenders think that if the score update works as intended, it'll benefit borrowers and mortgage companies alike for this reason.

"By using these scores, lenders can better identify which borrowers are likely to default on their loans. This helps to reduce the overall risk of lending," said Boris Dorfman, a long-time real estate professional and the founder/manager of LBC Capital Income Fund. "It provides consumers with more choices…and gives lenders another tool to assess risk.