Since the mortgage crisis, many media articles have been written about the overlays that lenders impose on top of the minimum credit quality standards established by Fannie Mae, Freddie Mac and HUD. Overlays are put in place because lenders, responsible for origination decisions, may not feel the criteria are strict enough based upon historical payment performance. These lenders are focused on sustainable homeownership, and want to avoid the high cost of delinquencies and foreclosure.
Post-crisis, there is an added risk facing lenders: having to buy back, or repurchase, a loan sold to Fannie or Freddie should it default and be found to not have met all lending guidelines. This risk is significant. Repurchase demands for loans originally sold off during the housing boom are in the billions of dollars for many lenders—and still growing.
Mainstream articles often discuss how borrowers are confused by the overlays. But isn’t the real question: have lenders over-tightened criteria, and as a result, are they missing out on making profitable loans to creditworthy consumers?
At FICO, we believe sharper analytics can help lenders make more informed decisions. When managing overlays, more insight into the borrower’s credit history can help lenders safely extend more mortgage credit to more good borrowers. Such insight would require more consumer data and analytics with a more precise performance definition.
How would this approach translate in a best-practice environment?
Here's a strategy we're beginning to work on with our clients. The lender would pull both a traditional FICO® Score and a FICO® Mortgage Score Powered by CoreLogic®. The traditional FICO Score is passed to the GSEs or FHA as required. The FICO Mortgage Score is used to inform internal credit policy decisions and business rules. This analytic leverages both traditional and supplemental consumer credit data, and is tuned for mortgage origination decisions.
In this scenario, let's suppose there's an applicant with a FICO® Score of 700 to a lender that has overlays requiring a 720 FICO Score. This applicant may meet the minimum credit standards established by the GSEs or HUD, but may not be approved by the lender because the score falls below its credit quality criteria.
The lender now also pulls the applicant’s FICO® Mortgage Score, which is a 720; this score reflects prior positive mortgage payment data not reflected at the credit reporting agencies because it’s from a paid-in-full mortgage loan no longer being reported. In this case, the lender could make the decision to continue underwriting the loan, safely increasing origination volumes beyond prior policy.
It all comes down to more data, better analytics, better decisions—a common mantra here at FICO, not just in mortgage, but across banking decisioning.