Murray, Michael
More than 30 percent of consumers dropped below a 680 credit score after October 2008, increasing mortgage rates and creating greater challenges for lenders.

More than 45 percent of consumers with 680-699 FICO scores improved their scores from October 2007 to October 2008, but 30.5 percent of consumers dropped below the 680 cutoff and 24 percent stayed the same, said a real estate consumer study conducted by FICO, Minneapolis.

Craig Focardi, research director at TowerGroup, Needham, Mass., said higher score cutoffs, combined with home valuation—appraisals in unstable and declining markets—and greater documentation requirements create greater challenges for lenders.

“There's been, perhaps, an expedient short-term response by raising these FICO cutoffs that meets the short-term needs of investors but does not meet the needs of consumers,” Focardi said. “I don't know that consumers with under a 740 FICO score, for example, should have higher fees or higher rates as a result. This blunt knife—one size fits all approach to looking at credit scores—needs to change and lenders need to look at customer populations more granularly when they underwrite. They can still do that without having to raise rates to consumers but still protect their own risk positions.”

Joanne Gaskin, product director at FICO, said myFICO.com—FICO's website—references components of the FICO score.

“We take the position of being sure we educate consumers about the [credit-score] components,” Gaskin said.

The myFICO.com website yesterday showed credit scores for premium annual percentage rates range between 760-850 for a 30-year fixed mortgage and 700-750 for the second best mortgage APRs. The minimum credit score was 620. However, 15-year equity loans, range between 740-850 for the best rate and a premium 36-month auto loan interest rate ranged between 720-850.

Dain Ehring, CEO and founder of CoreLogic Dorado Corp., San Mateo, Calif., said mortgage lenders hope to retain values on loans after discounting mortgages on their balance sheets, including prime loans, based on mark-to-market accounting.

“All they really want to do is get the same value,” Ehring said. “Because of this credit crisis, they have to devalue or discount a lot of those loans they have on the books—even prime loans. For new loans, they are really being very careful to discount those loans in the books.”

“Lenders, fortunately, are already looking at more aspects of the loan file besides the FICO score. In fact, they always have,” Focardi said. “The FICO score has been one tool, one analytic in underwriting loan applicants. In the subprime sector, the excessive reliance on scores in some cases, along with bad policies and bad management, was a contributing cause to the subprime crisis—certainly not the scores themselves.”

“Lending practices have changed and evolved over time, and we are certainly seeing [lenders] move back to that 'back-to-basics' lending,” Gaskin said. “The credit score is not just important in that overall piece but also making sure [lenders] are looking at collateral [and]documentation. We believe part of the issue we saw was that we moved away from those three C's of lending during the past few years. Although the FICO score may have been an important component in the decision, they certainly were not looking at all of the other aspects to fully document the creditworthiness as well as the collateral of that loan.”

However, higher interest rates can also make it more difficult for borrowers to refinance or purchase homes.

“It is a lot harder to get through that lending process, and it's a lot harder to qualify for that loan in the first place,” Ehring said.

Gaskin said FICO has its classic score across all industries, including mortgage lending, and it provides industry-option scores, “fine-tuned” for credit risk on mortgage loans, home equity loans and the automobile and credit card industries. 

“The algorithm is fine-tuned to the data at that credit bureau,” Gaskin said.

Based on loan workout statistics and the Mortgage Bankers Association's National Delinquency Survey, Focardi said servicers will face considerably more loans—more than 3 million mortgages in the next two years or more--and trends show favorable results from loan modifications rather than repayment plans or forbearance.

“Loan modifications are more permanent in their assistance to consumers and have started to pick up significantly in 2008,” Focardi said. “The trends in 2009 show the 2009 results are likely to outpace 2008. Programs are ramping up, which is good.”

Servicers could use the mortgage industry-option score, provided only through Equifax, to determine borrower potential for mortgage default, but originators need Experian and TransUnion to pick up the tri-merged mortgage-specific score. FICO creates a mortgage credit score that resides in each one of the credit bureaus—Experian, Equifax and TransUnion.

With different data in those credit bureaus, Fannie Mae and Freddie Mac guidelines require the middle credit score to represent the borrower.

“We only have that industry-option score at one bureau right now so it doesn't support that tri-merge approach. However, the goal is to get it at all three of the bureaus so that we could use the score at origination as well,” Gaskin said. “It's going to be used [today] within servicing operations so that they could see within their existing book of business more or less credit risk associated with their existing customer base.”