Credit Scores To Be Revised Amid Soaring Mortgage Defaults

This is a reprint of an article by Kenneth Harney,
a columnist for the Washington Post Writers Group.

***

With foreclosures soaring - and some homeowners
with unblemished payment histories walking away
from their houses with no advance warning - the
two major producers of credit scores have begun
changing how they evaluate consumer risks of
default. The revisions could touch you the next
time you apply for a loan.

In late October, both FICO score developer Fair
Isaac and VantageScore Solutions, a joint venture
by the three national credit bureaus and marketer
of competing VantageScore, outlined modifications
they are making to handle the vast credit disrup-
tions caused by the housing bust, the recession,
high unemployment and behavioral changes.

Overall, credit industry experts agree, consumer
creditworthiness has deteriorated in the United
States since 2006 - especially among what used
to be considered the credit elite, people with the
highest scores.

For example, a study this year by VantageScore
found that the probability of serious delinquency
- defined as nonpayment for 90 days or more -
had increased by 417 percent among "super-
prime" borrowers between June 2007 and June
2009. Default risk during the same period rose
by 406 percent for the second-highest rated
category of "prime" consumers and nearly
doubled for those at the "near prime" scoring
level.

The driving force, said Sarah Davies, Vantage-
Score's senior vice president for analytics and
research, is the "significant change in consumer
credit repayment behavior" that began during
the housing bust and recession.

Not only are borrowers who previously were
rated outstanding credit risks far more likely
to default today, she said, but many home-
owners are defying longstanding credit industry
assumptions by going delinquent on their first
mortgage payments while simultaneously
continuing to pay their credit card balances
and second mortgages on time. Strategic
defaults - walkaways - by high score borrowers
also have been an unexpected and shocking
development, she said.

To adjust its statistical models to these new
realities, VantageScore says it conducted
extensive research on 45 million active credit
files obtained from the databases of its joint
venture partners, Equifax, Experian and
TransUnion.

The research examined the same files - with
personal identifiers removed - during set
time periods between 2006 and 2009 in order
to capture emerging behavioral patterns
associated with defaults on various types of
credit accounts.

The resulting VantageScore 2.0, which is
expected to be rolled out nationwide to lenders
in January, focuses in on the subtle warning
signs of credit stress that might have been
missed earlier - and penalizes or rewards
consumers with higher or lower risk scores
than they would have received before.

Joanne Gaskin, director of mortgage scoring
solutions for Fair Isaac, said her company's
new FICO 8 Mortgage Score is based on
similarly exhaustive research into consumer
credit-behavior changes over the past four
years. When used by a lender to rate the risk
of new applicants or existing mortgage customers,
Gaskin says the Mortgage Score is likely to be
anywhere from 15 percent to 25 percent more
accurate in detecting signs of future default,
compared with the standard FICO model.

Though she would not discuss proprietary
details about the early warning signs that the
new score monitors, Gaskin said they include
broad patterns such as the following: A borrower
with a current 720 FICO score might have average
balances on a first mortgage, home equity lines
and other accounts that are higher than norms
pinpointed by the revised scoring software. A 720
FICO is considered a good score by most mortgage
lenders - often qualifying for favorable rates and
terms.

However, the same applicant might rate just a
680 FICO or lower if the lender used the new
Mortgage Score. The lender would then have a
choice: reject the applicant, quote a higher interest
rate on the mortgage or require a larger down
payment.

Gaskin said the reverse could also occur: The FICO
8 Mortgage Score could come in higher than the
standard FICO - indicating lower risk for the future -
in situations in which formerly troubled borrowers
manage to put themselves back on a healthier credit
track.

Experts in the credit industry say the new scoring
efforts by Fair Isaac and VantageScore should prove
to be a net positive for the housing and the mortgage
industries if they can do what they claim: spot subtle
risk patterns and nascent hints of improvement.

But as a mortgage applicant you should know that
your next score might not look anything like the
score you thought you had. You might end up
getting a better deal - or worse - when lenders
quote you rates and terms.

Glossary of Common Mortgage Terms

When you do research for a new home loan, it is not
uncommon to hear industry "shorthand" being used.

You may not always choose to have the person
explain the terms for fear of looking uninformed.
Here are some common acronyms and terms that
may help you better understand what you are
hearing.


APR The Annual Percentage Rate gives the
borrower a basis for comparing competing
interest rate and fee quotes by taking into
account the effect of the finance charges
expressed as an effective interest rate.

AUS An Automated Underwriting System is a
web-based program available to mortgage
lenders. With proper data input, it renders
an underwriting decision based on the
compatibility of the loan request to FNMA
and FHLMC guidelines.

CLTV Combined Loan to Value ratio is the
comparison of the loan amounts on the
first loan plus the second loan in relation to
the value of the home. For example, a first
loan amount of $300,000 combined with a
second loan amount of $100,000 on a
property valued at $500,000 represents a
CLTV of 80%.

FHA The Federal Housing Administration is part
of the Department of Housing and Urban
Development. FHA provides a system for
insurance of loans with lesser down payments.

FHLMC Known as "Freddie Mac", the Federal Home
Loan Mortgage Corporation was created in
1970 as a Government Sponsored Enterprise
to purchase loans from lenders and provide
liquidity to the mortgage market.

FICO FICO stands for Fair Isaac Corporation and
Scores has become the generic label applied to
credit scoring models. Through proprietary
modeling, each of the three repositories -
Experian, TransUnion and Equifax - produce
scores ranging from 300 to 850. Higher
scores are designed to be predictive of
more credit-worthy borrowers.

FNMA Known as "Fannie Mae", the Federal National
Mortgage Association was created in 1938 as
a Government Sponsored Enterprise to
purchase loans from lenders and provide
liquidity to the mortgage market.

GFE The Good Faith Estimate is a required
disclosure from lenders to the borrower, and
is to be provided within 3 business days from
receipt of a loan application. It's purpose is
to provide an estimate of fees and costs in
obtaining the home loan.

LTV Loan to Value ratio is the comparison of the
loan amount on the first loan in relation to the
value of the home. For example, a loan
amount of $400,000 on a property valued at
$500,000 represents an LTV of 80%.

Points A point equals 1 percent of the loan amount.
For example, on a loan amount of $200,000,
one point equals $2,000. When interest rates
are quoted there is often an origination fee
disclosed based on a certain number of points.

Pricing Refers to a combination of interest rate and
origination fee quoted on your transaction.
For example, you may hear pricing models
such as 4.5% with a loan fee of 1 point (see
above) or 4.75% with a loan fee of zero points.

TIL The Truth-In-Lending disclosure is designed
to show the borrower an effective interest
rate based on the combination of interest rate
and finance charges. The most significant part
of the disclosure is the Annual Percentate Rate.

VA The Home Loan Guaranty division of the
Department of Veterans Affairs guarantees
home loans to lenders for loans made to eligible
veterans. Loans made under this program often
allow the veteran to purchase a home with no
down payment.