The Path Forward for Fair Credit Scoring Competition
With changes underway at Fannie Mae and Freddie Mac, what could competition between credit score models mean for mortgage bankers?
The mortgage industry is on the threshold of a significant change. The “interim” policy announced by Federal Housing Finance Agency (“FHFA”) for implementing the Credit Score Competition Act has the potential to reshape the conforming mortgage market. In advancing this process, we believe the intent is to promote a strong and vibrant housing market, where competition and innovation reduce costs and expand homeownership.
For decades, the FICO® Score has delivered valuable predictive insights for mortgage lenders and investors, greater access to credit for borrowers, and ultimately better pricing for mortgage credit. FICO embraces competition in the conforming mortgage market, just as we do in every other consumer credit market. Given the dynamics that make conforming mortgage unique from other consumer credit markets (primarily the tri-merge requirement and the risk transfer to Fannie Mae and Freddie Mac (“GSEs”)), there are key areas that require special consideration to ensure actual competition that serves the interest of mortgage bankers, their customers, and other industry participants.
Championed by Senator Tim Scott and signed into law in 2018 by President Trump, the Credit Score Competition Act seeks to foster meaningful competition among credit score providers, ensuring the most accurate and reliable model is used in mortgage underwriting. If implemented consistent with this intent, this evolution can promote wider access to homeownership for Americans while upholding safety and soundness. As the industry continues working toward a multi-score, “lender choice” environment, FICO believes three fundamental principles can ensure fair credit score competition to advance the interest of mortgage bankers, investors, other industry participants, and ultimately borrowers.
1. Implement both previously validated and approved modern credit scores at the same time
Competition can only work when those making the choice (in this case, mortgage originators) can choose from the best and most advanced products available. The FHFA’s “interim” policy attempts to introduce “competition” between Classic FICO, a still highly predictive score, but one built more than 20 years ago, and a much newer alternative (VantageScore 4.0). The “interim” policy does not include acceptance of FICO® Score 10T, the most predictive modern credit score, which was previously validated and approved for use by the GSEs. As numerous stakeholders have stated, a phased implementation will be problematic and introduce additional costs for the mortgage industry.
To maximize the benefits of new innovations in scoring models and reduce implementation costs, FICO® Score 10T and VantageScore 4.0 should be implemented at the same time. Both scores incorporate the same data sources, such as rental payments and trended data. In the nonconforming mortgage market, FICO Score 10T is already seeing rapid adoption, driven by its industry-leading predictive power. Implementing FICO Score 10T simultaneously with VantageScore 4.0 will help FHFA and the GSEs deliver on the promise of modern credit scores to promote homeownership while maintaining the safety and soundness of the conforming mortgage market.
2. Ensure every credit score validated and approved by the GSEs can compete on a level playing field
A competitive marketplace is possible if each validated and approved credit score can compete on a level playing field. In a “lender choice” environment that includes a tri-merge requirement, competition on a level playing field is not possible because one of the approved credit scores (VantageScore) is jointly owned by the three major credit bureaus, who also control the data, pricing and the distribution channels used for both the FICO® Score and VantageScore. This lack of independence poses an inherent conflict of interest and diminishes fair competition.
In other consumer credit markets, lenders don’t have to purchase credit reports and scores from all three credit bureaus. Rather, they can freely choose between credit bureaus and credit score providers, with competition occurring at the credit bureau level and the credit score provider level. The tri-merge requirement in the conforming mortgage market gives the credit bureaus immense market power and both the ability and incentive to manipulate different levers in favor of their own score, VantageScore, while disadvantaging FICO and any other independent competitors.
This concern is not theoretical. The credit bureaus control the data and have the market power under a tri-merge mandate to condition access to credit report data on the use of VantageScore leading any supposed “lender choice” option to vanish. This dynamic also enables the credit bureaus to disadvantage independent credit score providers more subtly, such as by manipulating the pricing for credit scores or the credit data needed for scoring to advantage VantageScore. Put simply, true competition cannot exist when the bureaus are vertically integrated into scoring through their ownership of VantageScore. In order to safeguard against these risks, regulators have multiple potential solutions, including removing the tri-merge requirement to promote competition at the credit bureau level (similar to how other consumer credit markets work) or requiring that all validated and approved credit score providers are independent from the credit bureaus that control the sale, distribution and pricing of credit scores and reports.
Other stakeholders may have different perspectives on how to maintain a level playing field in a competition where one participant is owned by the entities who also fully control the pricing and distribution channels for both products. But without some protection against anticompetitive behavior by the credit bureaus in favor of VantageScore, the scoring provider they own and control, the original vision of the Credit Score Competition Act will not be realized.
3. Foster robust data transparency to ensure market stability
Effective competition requires that all market participants have access to as much information as possible about the performance, pricing, and implications of different credit scoring models to make informed decisions. Today, the mortgage ecosystem relies heavily on decades of historical data about what a FICO® Score means for evaluating and pricing borrower credit risk. As new models are introduced, stakeholders will need robust analogous data to update risk models and protect market stability. The FHFA and the GSEs should explore ways to provide industry participants with the most complete data possible to facilitate a seamless transition, limit costs for market participants, and minimize market risk.
Numerous stakeholders have pushed for the release of comprehensive historical datasets that allow for a full assessment of FICO® Score 10T, Classic FICO, and VantageScore 4.0. To avoid skewed results and enable fair and accurate comparisons, these evaluations should encompass data from all applicants, not just the population of borrowers approved for loans under the GSE underwriting standards. One additional and immediate opportunity is responding to the industry’s repeated requests for disclosure of any results and recommendations of the GSEs’ Credit Score Assessments with respect to FICO Score 10T and VantageScore 4.0. Publishing this information for all industry stakeholders will inform and ultimately expedite the implementation process. Though the loan level data set the Credit Scoring Initiative project plan includes is not comprehensive at the application level, FICO remains committed to working diligently with the GSEs and FHFA to make FICO Score 10T available for industry stakeholders.
The path forward
Greater competition in the conforming mortgage market can deliver better outcomes for lenders, consumers and the broader economy. In order to achieve a truly fair and competitive environment, FICO® Score 10T should be implemented simultaneously with VantageScore 4.0, recognizing the complexity, cost and importance of this transition to the entire industry.
The path forward requires a careful balance: embracing innovation, ensuring fair competition, and maintaining the stability and trust that underpin the housing finance system. By adopting the most advanced credit score models (including FICO® Score 10T), addressing the threats to competition of vertical integration with the tri-merge requirement given the credit bureaus’ ownership of VantageScore, and promoting data transparency, the FHFA and the GSEs can deliver lower costs for mortgage bankers and their customers, expand access to sustainable mortgage credit, and enable a stronger, more prosperous housing market.
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FICO® Score High Achievers: Is Age the Only Factor?
<p>FICO’s latest research on <a href="http://www.fico.com/en/blogs/risk-compliance/us-credit-quality-rising-the-beat-goes-on/" target="_blank">national FICO® Score distribution</a> shows that US credit quality continues to trend upwards, with an increasing number of consumers scoring in the highest scores ranges. Given that, we decided it was time to refresh our study on “<a href="http://www.fico.com/en/blogs/risk-compliance/infographic-what-does-a-high-credit-scorer-look-like/" target="_blank">FICO® Score high achievers</a>,” where we examine the credit behavioural profiles of consumers with higher credit scores.</p> <p>As expected, our latest study showed that older people generally have higher scores, as has been the case in our <a href="http://www.fico.com/en/blogs/risk-compliance/age-before-beauty-credit-worthiness-before-youth/" target="_blank">past research</a>. This is largely because they have trade lines that have been open longer, which leads to higher scores (assuming the trade lines are in good standing and all other things equal). The most credit savvy among you will remember that length of credit history accounts for roughly 15% of the overall <a href="http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx" target="_blank">FICO® Score calculation</a>.</p> <p>But for younger consumers, it isn’t too helpful to say, “just wait until you are 50 years old, and that will fix things!” Thus, I decided to dive deeper with our analysis, including looking at the credit behavioural characteristics of younger consumers with high FICO® Scores.</p> <p>In this analysis, I looked at credit characteristics for the two highest score bands, 750-799 and 800-850, which have about 16% and 23% of the population, respectively. I further broke this down by looking at the characteristics of the youngest 15% in each group, which occurs at age 29 for the 750-799 group and 43 for the 800-850. We used FICO<strong>®</strong> Score 9 for our analysis, and examined typical variables of the categories that go into the make-up of the score.</p> <p><a href="http://www.fico.com/en/blogs/wp-content/uploads/2016/10/FICO-Score-High-Achiever-table.png"><img class="alignnone size-full wp-image-29367" src="http://www.fico.com/en/blogs/wp-content/uploads/2016/10/FICO-Score-High-Achiever-table.png" alt="fico-score-high-achiever-table" width="715" height="747" /></a></p> <p>Since there’s a lot to dissect in this chart, I’ll highlight a few findings that struck me: <ul> <li><strong>Credit history.</strong> Higher scores are undoubtedly associated with a longer time on file. What’s striking is the higher average time on file for the 800+ group, both overall and for revolving accounts (the most common trade line). Clearly, it helps to start credit use early in life – but that’s not the sole determining factor for high scoring. The younger cohorts in both the 800+ and 750-799 groups have time on file medians significantly less than their older counterparts.</li> <li><strong>New credit.</strong> High credit scorers do, in fact, pursue new credit. We see little variation in months since last trade line opening and last inquiry among all groups observed.</li> <li><strong>Pay on time.</strong> As you might expect, the further in the past the delinquency, the higher the score – and that’s <u>if</u> a delinquency ever happened. 95% of the 800+ people and 72% of the 750-799 group have never been delinquent, which is a striking contrast to the 57% for the total population. The percentages for the younger groups are even higher, especially so for the 750-799ers. Collection items are also scarce for these high scorers. While 23% of the national population have collection items greater than $99, the figures are only 0.5% for the 800+ group and 3% for the 750-799 group. It is clear that, in conjunction with starting a credit file early, paying on time is a key trait of the FICO® Score high achiever.</li> <li><strong>Balance and utilization.</strong> Finally, we look at how credit is being used, focusing on revolving product use. (Since most people only have one mortgage or one auto loan, variation in instalment product figures is minimal and driven by payment history, which is near perfect for high scorers, as we’ve seen.) FICO® Score high achievers tend to have more open revolving accounts. While the % active trades and utilization are generally lower, by no means do high scorers avoid the use of credit products. What drives the difference here is the amount of <u>available</u> revolving credit utilized. The 800+ group is roughly 1/4 of the national median, both in total and on their highest utilized card; they also have lower balances and more cards<em>. </em>The 750-799 group is more active and higher utilized, but still only at 2/3 of the national figures. The young 750-799 group compensate with lower revolving balances and, as a result, lower utilization, which is in line with what we see for the 800+ group.</li> <li><strong>Benchmarks.</strong> I’d like to point out that while this study provides good benchmarks of the typical credit traits of the FICO® Score high achiever, individual credit profiles will vary widely. And keep in mind that when we sort groups of consumers as a whole by different behaviours, some results may look superficially odd. For example, the 800+ band has a longer median average open account time (128 months) than average revolving months on file (140 months).</li> </ul> So, what do we conclude? A huge takeaway is that high scorers don’t have too much in the way of serious delinquencies and negative public record data.</p> <p>In most respects, the young 800+ people are like their peer group. They really only differ markedly in their shorter credit history and higher non-mortgage balance, both of which are a function of life stage. Our results show that you don’t have to be a credit product hermit; these high scorers have more credit cards. The takeaway is to start credit activity early and maintain well-managed and moderate usage.</p> <p>In many ways, the young 750-799 people are more interesting because their age profile is much younger. Their credit characteristics differ more from their peer group, particularly in terms of length of credit history. They compensate by having almost pristine credit records and lower balances.</p> <p>Ultimately, 39% of US consumers are FICO® Score high achievers, which they accomplish by following common-sense credit practices. It ain’t rocket science!</p>
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