Credit scores have always been an important number that affects homebuyers’ ability to qualify for mortgages and specific rates. Ever since the 2008 crash, the importance of credit scores in the home buying and loan qualification processes has reached an all time high. It is certainly an oversimplification to say that a high credit score usually results in qualification for a low rate, while a low credit score typically meant a higher rate or no qualification at all. But that statement is also generally true.
Credit scores, widely known as FICO scores, were originally established by Fair Isaac Corporation to provide lenders with a basis for measuring risk and loan eligibility for borrowers. Credit scores are calculated using sophisticated algorithms that analyze consumer credit behavior, which is recorded and monitored in credit reports produced by three organizations: Experian, Equifax and TransUnion. Credit scores range from 300 (not good) to 850 (excellent).
This fall, FICO is announcing revisions to the formula it uses to calculate people’s credit scores. For certain groups of consumers, the revisions will result in better credit scores and better chances for home shoppers to qualify for mortgages and lower rates. The new formula, named FICO 9, will include several changes, but the three revisions that are likely to have the biggest impact for homebuyers and loan seekers are:
No credit history, no problem
- Credit scores assigned to consumers with little or no credit history
- Removal of closed or settled collection accounts from the formula
- Reduced emphasis on medical debts
Some people have little or no credit history, either because they are young and haven’t had time to establish credit, or because they intentionally avoid using traditional credit payment options. Currently, a lack of credit history is perceived by FICO as a negative and lowers credit scores. Under FICO 9, non-traditional sources will be used to help determine credit scores for people with minimal credit histories. For example, FICO will look at payment history and patterns related to cable, Internet, phone, utility and other bills and assign a credit score based on a person’s track record for regularly paying bills on time. FICO 9 will open the door for a substantial number of people without credit to get credit – and probably at fairly reasonable rates.
Settled collections won’t count
Another FICO 9 adjustment that plays in favor of borrowers is a new rule that says that all accounts that were in collections but have either been paid as part of a settlement or paid in full won’t be considered in the credit score calculation.
With the current FICO formula, the negative impact of a settled collection account can easily disqualify a loan applicant from approval. Let’s face it – sometimes people are faced with an unavoidable circumstance that makes it impossible to pay off certain debts. With FICO 9, people that square up past debts and get back on track may not receive a reduced credit score for old collections accounts.
Medical debts won’t hurt quite as much
Currently, medical debts are given the same weight as many other debts in FICO credit score calculations, which means that if you’re not paying off your medical bills in a timely fashion, your credit score is being damaged. However, since research shows that unpaid medical debt is not a reliable indicator of the probability of other delinquencies, like credit card balances or mortgage payments, FICO 9 is decreasing the weight assigned to medical debt in its credit scoring formula. FICO believes this formula revision will result in a 25-point increase in the credit scores of people who have overdue medical debts but no other overdue debts.
Of the three revisions listed here, the reduction of the negative impact of medical debts will likely have the least effect on consumers because many lenders already discount those debts as relative risk factors and make manual adjustments to their qualification models.
It’s unclear how many people will actually benefit from FICO 9, and the reality is that any noticeable change is probably quite some time away. As a rule, the mortgage industry as a whole is cautious when adapting to change and implementing eligibility requirement changes. However, at a time when qualifying for a mortgage has been getting more and more difficult, it is nice to hear that some actions are being taken to shift the momentum of that disturbing trend.
Patrick Stoy has 15 years of mortgage lending experience. Patrick is CEO of Wilmington-based Market Consulting Mortgage, which he started in 2005 with a mission to build lifelong customer relationships by providing real value. To learn more about Marketing Consulting Mortgage, visit www.macmtg.com. Patrick can be reached at [email protected] or 910-509-7105.