The venerable FICO scoring system for rating borrower’s credit has been a foundational piece of the mortgage process for nearly 30 years. The major credit bureaus (Equifax, Experian, and TransUnion) compile consumer credit files, which are then used to calculate the FICO credit score. While the system was the best attempt for a mathematical solution to replace an otherwise subjective underwriting system, many agencies feel the scoring system has become antiquated.
Switching to a new system, though, would take a substantial effort for organizations like Fannie Mae and Freddie Mac. If an alternative credit scoring system could be implemented, here are the key aspects that would be addressed.
The goal of the Federal Housing Finance Agency along with Fannie Mae and Freddie Mac is to ensure as broad availability for housing to American consumers as possible. The question then becomes how effective a tool is the FICO scoring system to enabling that mission statement?
Are Americans that are new to the workforce unfairly disadvantaged? What about self-employed borrowers? How about Americans that don’t access credit very often?
One way to approach this question is to ask another. Are there Americans capable of repaying a mortgage loan with the desire and honest intent to do so that might not qualify for a loan under the current credit system? The answer is, of course, yes, which means there is always room for improving the process in which credit is evaluated.
The means of compiling an accurate credit history that can be then be scored is a difficult undertaking. Every loan officer tells their prospective clients to check their credit histories before submitting an application, because errors are quite common. One study revealed that nearly 1 out of 5 credit reports in the United States had errors on them. Worse yet, other studies show that this number could be substantially higher. These errors come in the form of mistakes, false attribution, or even identity theft.
An accurate credit history can be the difference between a yes and a no on a home loan application. It is absolutely critical that these reports are accurate for fairness to the prospective buyer.
The FICO scoring system uses a combination of several different consumer behaviors to determine a credit score. The goal was to determine the potential risk to the lender on extending credit based on patterns of behavior as seen by successful borrowers compared delinquent repayments.
Below is a broad breakdown of the FICO scoring system. The specific metrics on how these scores are tabulated are kept secret.
- Payment History: 35%
- Debt Burden: 30%
- Length of Credit History: 15%
- Types of Credit Utilized: 10%
- Recent Credit Searches: 10%
The information collected on these different events comes from all types of sources, including lenders, creditors, and the consumers themselves. A close examination of the fluctuation of individual credit scores reveals how micro-behaviors can increase or decrease a FICO score by several points for seemingly innocuous events.
With so much data available on both the borrower, the loan, and the lender, better analytics can be applied to simplified and improve the FICO scoring system.
Pacific Union Financial
Pacific Union Financial, LLC is a full-service mortgage lender providing originations and loan servicing across the United States. A privately-held direct lender with Fannie Mae, Freddie Mac, and Ginnie Mae approval, we originate loans through our Retail, Wholesale, and Correspondent channels. Let us know how we can help you expand your business.