For More Affordable Mortgages, We Need Inclusive Credit Scores
Since the early part of this decade, Government Sponsored Enterprises (GSEs)—Fannie Mae and Freddie Mac—have used an outdated credit score called Classic FICO. In response to a request for information (RFI) from the Federal Housing Finance Agency (FHFA) released in late December of last year, Prosperity Now recently provided feedback about how the GSEs should update their credit scoring model.
The significance of updating this score cannot be understated. Fannie Mae and Freddie Mac do not originate mortgage loans, but they do buy loans made by other lenders—quite a few loans, in fact. Together, Fannie Mae and Freddie Mac guarantee more than half the mortgages made in this country. With such an expansive footprint, the credit scoring model they adopt to help determine whether a mortgage should be purchased has a profound impact on the credit reporting and scoring market. The FHFA’s RFI is a welcome development, signaling that the agency is taking the need for an update seriously.
According to the Consumer Financial Protection Bureau (CFPB), 45 million people do not have a credit score. Prosperity Now’s Scorecard shows that for those with a score, almost half have poor (subprime) credit. Low-income families and households of color are more likely to have no or low scores. If designed sensibly, a new score could bring a significant number of people into the credit mainstream, make credit more affordable for people who already have scores and help families with mortgages build wealth more easily.
For this request, the FHFA is considering two newer scores: FICO 9 and VantageScore 3.0. Changes from Classic FICO include no longer keeping debt that is eventually paid on a person’s credit report, meaning medical debt that lands on a report but is paid off at some point will be removed. Medical debit is one of the worst offenders when it comes to putting credit at risk. FICO 9 also lowers the impact that unpaid medical debt has on scores, which improves scoring accuracy.
In our letter, we argue that onboarding either of these scores is an improvement over continuing Classic FICO. We also outline a set of criteria that we believe are the foundation of a strong scoring model. These include increasing inclusivity and incorporating alternative data (debt repayment histories that are usually not reported to the credit bureaus) into the model, namely rent, utilities and phone payments. Families currently don’t receive any credit for routinely paying off this type of debt, even though evidence exists to suggest that scoring models do not lose predictive power when these payments are included. Last Spring, we submitted a comment letter to the CFPB that spells out the value of factoring these payments into the scoring model.
For the sake of innovation and competition, we also recommend that Fannie Mae and Freddie Mac systematically re-evaluate the scores they use to make room for the adoption of newer, stronger models in the future.
Credit has a substantial impact on a person’s financial security, and it is important for the GSEs to promote a strong score that does not only benefit people at the top of the income distribution. We hope the FHFA will consider our recommendations.