Alternative credit scoring could boost homeownership

The talk about alternative credit scoring models continues to heat up, and if utilized correctly, has the potential to increase homeownership. 


Most lenders currently use FICO 2, 4 and 5. Although there are much more advanced credit scoring models on the market, including newer versions from FICO itself, Fannie Mae and Freddie Mac use the older versions, and require it for a qualified mortgage. 


The Federal Housing Finance analyzed options for using other models, looking at Classic FICO, FICO 9 and VantageScore 3.0, a credit score created by the three credit reporting agencies: Experian, Equifax and TransUnion, however it eventually decided to rule out the VantageScore option. 


The FHFA ruled that the GSEs could not use the VantageScore credit scoring model because of conflicts of interest with the company’s backers. 


FHFA final rule


The FHFA sent a final rule to the Federal Register in August for the validation and approval of third-party credit score models that can be used by Fannie Mae and Freddie Mac. The rule implements the requirements in Section 310 of the Economic Growth, Regulatory Relief, and Consumer Protection Act enacted on May 24, 2018.  


The new rule lays out a four-step validation process for the approval of any new credit scoring to be used by the GSEs:


  1. Solicitation of applications from credit score model developers
  2. Submission and initial review of submitted applications
  3. Credit score assessment
  4. Enterprise business assessment


“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,” FHFA Director Mark Calabria said. “The final rule we are publishing today is an important step toward achieving that goal.”


The rule will become effective 60 days after its publication in the Federal Register. Within 60 days of this effective date, the FHFA will begin review of the materials the enterprises plan to use in the public solicitation process. After FHFA approves those materials, the enterprises will make details of the solicitation process publicly available. The FHFA will determine the date that the initial solicitation will open for credit score model developers to apply.  The enterprises’ solicitation period will remain open for 120 days.


Solicitation of applications from credit score model developers: The solicitation would include dates for the solicitation period, a description of the information that must be submitted with the application, a description of the enterprise process for obtaining data for testing, a description of the enterprise’s process and criteria for conducting their validation and approval and additional information required by the enterprise, subject to FHFA review and approval.


Submission and initial review of submitted applications: The proposed rule would require the enterprises to determine whether each application submitted is complete and includes all required fees. Each applicant would be required to submit an application fee, fair lending certification, information to demonstrate its use by an industry, a conflicts of interest certification, and any other information required by an enterprise. The enterprise also would obtain any data necessary for testing. Applicants would be responsible for the cost of an enterprise obtaining the data, and an application would not be complete until the third-party data has been received.


Credit score assessment: This phase would test each credit score for accuracy, reliability and integrity outside of the enterprise’s business systems. This phase must be completed within 180 days of notification to the applicant, with two possible 30-day extensions. In assessing accuracy, the proposed rule seeks comment on four different approaches: comparison-based approach,

champion-challenger based approach, benchmark-based approach and transitional approach. All applicants that meet the requirements of this phase begin the enterprise business assessment phase.


Enterprise business assessment: This phase would assess the credit score model in conjunction with the enterprise’s business systems that use borrower’s credit scores as part of criteria for the purchase of mortgage loans. The enterprise business assessment would evaluate accuracy and reliability within the enterprise systems, impacts on fair lending, possible competitive effects from using a particular model, an assessment of the model provider as a potential vendor, the impact to the mortgage finance industry and the impact on the enterprise’s operations and risk management. This phase must be completed within 240 days. A credit score model may be approved by an Enterprise during this phase, subject to FHFA review and approval. If an application is approved, the credit score model will be implemented by the enterprise in its systems. Any approval of a new credit score model will be publicly announced.


To read more about each stage, click here


 Alternative credit scoring boosts homeownership


The use of alternative credit scoring has the potential to boost homeownership across the U.S., a new study from the Consumer Financial Protection Bureau found


Back in 2017, the CFPB issued a request for information regarding the use of alternative data and modeling techniques in the credit process.


And now, the CFPB released the results of a study on alternative credit conducted by Upstart Network, a company that uses alternative data and machine learning in making credit underwriting and pricing decisions. 


The Upstart Network’s underwriting model uses traditional underwriting data and various categories of alternative data, including information related to borrowers’ education and employment history.


The results provided from the access-to-credit comparisons show that the tested model approves a full 27% more applicants than the traditional model, and yields 16% lower average APRs for approved loans. 


This reported expansion of credit access reflected in the results provided occurs across all tested race, ethnicity and sex segments resulting in the tested model increasing acceptance rates by 23% to 29% and decreasing average APRs by 15% to 17%.


The use of alternative credit showed that near prime consumers, or those with FICO scores from 620 to 660, are approved about twice as frequently. The study also showed that applicants under 25 years of age, an age segment that tends to have thinner credit files, are 32% more likely to be approved with the use of alternative credit. And consumers with annual incomes less than $50,000 are 13% more likely to be approved. 


With regard to fair lending testing, which compared the tested model with the traditional model, the approval rate and APR analysis results provided for minority, female and 62 and older applicants show no disparities that require further fair lending analysis under the compliance plan, the CFPB stated.


A move to alternative credit


While the use of alternative credit still isn’t being used for mortgages, more companies are starting to encourage the use of alternative credit by asking consumers to hand over more information in exchange for potentially higher credit scores. 


Back in December, Experian announced its new Experian Boost which allows consumers to grant the company to connect to their online bank accounts in order to access utility and telecommunications payments. It then adds this information to their Experian credit file and updates their FICO scores in real time. 


“Globally, we are constantly innovating and leveraging technology to find new ways to help consumers gain access to quality credit, while promoting fair and responsible lending,” Experian Global CEO Brian Cassin said. “We are committed to financial inclusion, and Experian Boost is the latest example of our efforts to increase consumer awareness of credit’s impact and value while giving them greater control.”


Kelsey Ramírez