Changes to the way credit scores are calculated are on the horizon, and for many prospective homeowners, this could be a good thing.
For many years, Fannie Mae and Freddie Mac, the government-controlled entities that guarantee U.S. mortgage loans, have required lenders to base creditworthiness of prospective borrowers on FICO scores. Non-bank lenders have argued that the FICO scoring model — which aims to predict how likely consumers are to repay their loans based on factors including credit history — is too restrictive. These non-bank entities say that by using only the FICO scoring model, millions of potential borrowers are being excluded from the mortgage market.
Now, there is a proposal from the Federal Housing Finance Agency (FHFA) to open up the housing market by also using the VantageScore as a measure for extending home loans to borrowers. Last month, the FHFA asked lenders to chime in on the issue. If changes are made it would mark the first time in nearly two decades that there has been an overhaul to the way credit is scored.
By including the VantageScore model, created by Equifax, Experian and TransUnion, more borrowers would be likely to qualify for mortgages. VantageScore says it could assign credit scores to 30 million more people than FICO and potentially make 7.6 million more people who use little to no credit eligible for a mortgag
“Doing something just because you’ve always done it that way isn’t a good enough reason,” Mat Ishbia, CEO of United Wholesale Mortgage, told The Wall Street Journal.
Understanding the difference between FICO and VantageScore
The FICO score is more widely used than VantageScore currently, and its use extends beyond mortgages. FICO scores are used by 90 of the top 100 largest U.S. financial institutions in making consumer credit decisions. FICO scores range from 300 to 850, with 300 being very poor and 850 being perfect. A credit score of 690 is in the high range of average. But a score above 720 will help borrowers secure the lowest mortgage interest rates
FICO uses five criteria to calculate credit scores, and each is weighted differently:
- Payment history, or your record of repaying your debts in full and on time = 35 percent
- The amounts you owe on credit accounts, or the ratio of available credit to how much credit you’ve used = 30 percent
- The length/age of your credit history accounts = 15 percent
- The amount of new credit for which you’ve applied = 10 percent
- The different types, or mix of credit you have = 10 percent of your score
While there are some loans available to borrowers with credit scores below 690, some government-backed loans such as FHA, require a minimum score of 580 or the borrower is required to put at least 10 percent down on the loan.
VantageScore was established in 2006 by the three credit bureaus — Experian, TransUnion, and Equifax with the goal of providing “a more consumer-friendly alternative” to the FICO score, but it is not yet as widely used.
Like FICO, a VantageScore ranges from 300 to 850, but the score focuses on some non-traditional information and places less emphasis on some of the factors that go into FICO scoring, for example, available credit. VantageScore places the highest emphasis on payment history, and age and type of credit. It places less emphasis on factors like recent behavior, including new credit accounts opened, and on the amount of unused credit available to a borrower.
FICO striking back
In responding to the proposed changes in the way mortgage creditworthiness is measured, FICO was quick to point out that its model is independent of the three credit reporting companies.
“FICO welcomes competition — we just want to have fair competition,” said Joanne Gaskin, senior director at the company. She also questioned whether lenders would expand credit responsibly simply by switching to VantageScore.
Meanwhile, FICO said it has a newer version of its model, which aims to provide a more sophisticated analysis of creditworthiness than the system currently used by Fannie Mae and Freddie Mac.
While many welcome the potential changes, which could put home ownership within reach of more Americans, some banks worry that a change could loosen lending standards too much, resulting in more mortgage defaults.
But nothing has been finalized and the FHFA said it will seek comment on the issue until February. Until that time, it will continue to consider different options, including using scores from both FICO and VantageScore or giving lenders a choice.
If your credit score has stopped you from becoming a homeowner, you may want to look into credit repair. By repairing your credit and improving your credit score now, you’ll have a much better chance of qualifying for a mortgage no matter which scoring model your lender uses.
If you’re concerned about your credit, you can check your three credit reports for free once a year. To track your credit more regularly, Credit.com’s free Credit Report Card is an easy-to-understand breakdown of your credit report information that uses letter grades—plus you get two free credit scores updated each month.