The Federal Housing Finance Agency released new guidelines in October 2022 for credit scores Fannie Mae and Freddie Mac can accept from lenders. Although the changes will take some time to implement, they could have a significant impact on those who have been historically excluded from homeownership. The updated credit scoring models could allow more borrowers access to mortgages. This is what happened, and how it may benefit those who are looking to buy a home.
Replacing obsolete credit score models
Fannie Mae and Freddie Mac are vital to the home lending industry because they purchase mortgages from lenders. This frees up money that can be used to make home loans. Fannie and Freddie are limited to conventional loans that meet certain criteria, including credit scores for borrowers.
FHFA is responsible for determining what credit scores Fannie and Freddie can accept. This in turn affects the scores that mortgage lenders use to evaluate loan applicants. FICO Scores 2, 4, and 5 are no longer acceptable by mortgage lenders. The mortgage industry had no choice. Credit expert John Ulzheimer explained that they were forced to use older FICO scores from the FHFA in an email. “All other lenders have long since abandoned those legacy scoring models. ”
The FICO 10T Advantage and VantageScore 4
Two major parts were included in the FHFA announcement. The main news is that lenders will now be able to use an updated FICO score, the FICO 10T, to assess borrowers. They can also use VantageScore scores from FICO competitor. The FHFA no longer requires credit reports from the three major credit bureaus. Lenders can now provide only two of these credit reports.
VantageScore and FICO 10T adoption is the headline. However, both models use trended information, which Ulzheimer describes to be like looking at a multidimensional view, rather than a flat picture. Trended data includes two years of financial information, not just the date the credit report was pulled.
These models also collect data from multiple sources, including payments for rent, utilities, and cell phone service. VantageScore is likely to be more accessible than FICO’s six month minimum credit history. It requires only one month of credit history. VantageScore claims it has scores for over 37 million Americans that don’t meet FICO’s criteria. Of those, more than 13 million have credit scores above 620. This is the most common threshold for mortgage lending.
VantageScore 4 and FICO 10T are ideal to get a better picture of potential borrower’s finances. Lenders can choose to use either one or both if the mortgage applicant does not have them both. This could be beneficial for borrowers with a VantageScore, but not on FICO’s radar.
Why is it important to report rent for mortgage applicants
Although it doesn’t sound like much, updating credit scoring models could have important implications for closing the racial homeownership gaps. According to the Urban Institute, 53 million Americans do not have FICO scores based on older scoring models. According to Urban Institute analysis of 2018 data from Freddie Mac, underrepresented minorities are more likely to have low FICO scores than white households (16.7%) and Black households (29.5%). These groups are less likely to own a home, with a lack of credit score information likely playing an important role. Pew Research Center’s analysis of 2019 census data revealed that 58% of Black-led households rent, and 52% of Hispanic or Latino-led homes are renters. 27.9% of white-led, non-Hispanic households, however, are renters.
People who have not been approved for mortgages before may be able to benefit from more inclusive credit scoring models that take into account rent payments and other information. This has been difficult because very little rental data is reported by credit bureaus. Jung Hyun Choi, senior research associate at the Housing Finance Policy Center at Urban Institute, a nonpartisan think-tank, says that reporting large amounts of data to the bureaus for institutional landlords is relatively simple. Choi points out that reporting is not as simple for “individual mom and pop landlords”, who tend to own small, one-to four-unit rental properties.
There are services available that allow landlords and tenants to report rent payments to credit bureaus. Freddie Mac launched a pilot program to encourage rent reporting by “mom and pop” owners of multifamily housing. Fannie Mae also offers a rent-reporting service.
Choi claims that renters have been less likely to report rent than landlords. This is because they don’t know how reporting rent can help improve their credit scores or access to homeownership. Rent is often the largest monthly expense in a family’s household budget. A history of paying rent on time correlates with being able to pay a mortgage consistently, so this is valuable data for lenders.
Tenants who are hesitant to enroll may be worried about their ability to pay rent on-time. Choi points out that rent-reporting software often unenrolls tenants if they miss a rent payment. This is so tenants don’t get double penalized if the missed rent payment goes to collections.
How to be a better mortgage applicant
These new credit standards could be beneficial to many Americans. There are steps you can take that will make you a more qualified candidate for a mortgage.
Open a bank account
If you don’t have a lot of credit history, your banking data could be a good alternative to lenders. You can build a record showing mortgage lenders that you are responsible with your money by opening a bank account and then using it to pay your bills. You might consider opening a second-chance account if you have been denied a bank card in the past. However, although your bank records may be used as a substitute for credit data, they won’t improve your credit score.
Ask your lenders about the scores they use
FHFA expects that the transition to new scoring models will take many years. This means that not all lenders will immediately be able to use FICO 10T and VantageScore 4. If you are looking for mortgage lenders, it is worth speaking to a loan officer. This information will not be on their website. A mortgage broker can help you find lenders who offer the most current scores if you’re looking for them.
Search for lenders who work with credit-challenged borrower
You may have difficulty finding a lender who accepts your newer credit scores. Instead, look for a lender who will consider alternative credit data and offer manual underwriting. Alternate credit data can often include information that can be gleaned directly from your bank account such as your rent payments or overall cash flow. Manual underwriting may allow for more flexibility in evaluating your loan application based on criteria that might not be included in the algorithms of some lenders.