February 20, 2018 Barrett Burns
As regulator and conservator of the GSEs, Mel Watt, the director of the FHFA, has a decision to make. He could open the GSEs’ credit score requirements to include other credit scoring models, eliminating the scoring monopoly created by the GSEs.
Or Director Watt could decide to use the same methods again. This decision would kick the can down the road leaving the industry with no choice but to repeat this three-year saga when, inevitably, models are rebuilt again.
The stakes are high. In the mortgage market, a credit score is used as a gateway that determines product eligibility and pricing for every applicant whose loan is ultimately purchased by one of the GSEs.
If true and honest competition is facilitated and another mandate is avoided, lenders can choose for themselves if they want to use VantageScore or FICO, depending on what they determine makes sense for their businesses.
Ultimately, this issue is about two things: better serving consumers and supporting sustainable competition, thus creating a level playing field for new entrants.
THE LONG AND SHORT TERM BENEFITS FOR CONSUMERS
Homeownership is currently at a 50-year low. Director Watt’s decision could improve access to responsible and mainstream credit both in the near and long-term.
By our estimate, 2.5 to 3 million additional consumers, many of whom are minority borrowers, could become mortgage-eligible. In addition, consumers with no score or low scores resulting from legacy scoring models, who today self-select out of the process, would be incentivized to explore whether homeownership could be right for them. These consumers would still be subject to reliable underwriting requirements that include analyzing a consumer’s capacity to repay a mortgage loan.
Looking longer term, the Mortgage Bankers Association estimates that household growth will be led by 5.7 million additional Hispanic households, 5 million additional non-Hispanic white households, 2.4 million additional black households, 1.9 million additional Asian households and 730,000 additional other households.
Clearly, Director Watt needs to make a prescient decision because restrictive credit scoring models will not adequately support this anticipated demographic shift. The market should be opened to include models that are able to score more of these consumers without compromising predictiveness.
COMPETITION, COMPETITION, COMPETITION
It is inarguable that no one company should have a monopoly in determining consumers’ creditworthiness.
Competition strengthens markets, makes them more efficient and always benefits stakeholders. Competition between VantageScore and other credit agencies has already led to many model innovations. Indeed, since 2006, competition has led to multiple new versions of VantageScore and other models. These new versions continue to improve in terms of consistency, predictive power, and consumer-friendliness.
TIME FOR A REALITY CHECK
VantageScore 3.0 is the model that FHFA is considering. Launched in 2013, VantageScore 3.0 made significant strides in using credit file information to score millions of consumers who were unable to obtain other scores. The model also scores those who are conventionally scoreable.
The success in this arena has often been mischaracterized by the competition as one that has resulted from “lowered standards.”
REALITY CHECK #1: VantageScore is empirically derived, tested, and continually validated under regulatory scrutiny. Thousands of lenders currently use VantageScore, and in which case they would have all tested the model and found it to be safe and sound.
We also analyze our models internally, and we publish the statistical validations of our models’ predictive power across all populations. Those reports, which include testing the scores assigned to the expanded population of scoreable consumers, are freely downloadable on our public website. The ability to confirm VantageScore’s claims of predictiveness is made available to all who actually choose to seek that information out.
Regarding the GSEs, the phrase “race to the bottom” between VantageScore and the competition has been raised. The reality is that this isn’t possible when regulated lenders ultimately validate models prior to implementation and use the ones that are most predictive. Further they are not meant to be used to replace the established underwriting safeguards already in place.
REALITY CHECK #2: Despite changes in credit file data and consumer behaviors, competition has maintained the same arbitrary minimum scoring criteria since its first generic model.
Indeed, the requirement that a consumer be “credit active” in the previous six months in order to be scored is likely an effort to ensure that lenders never have to “look under the hood” of their loan origination systems. Doing so would mean benchmarking against competitive models and a potential further erosion of its market dominance.
REALITY CHECK #3: A credit scoring model cannot and should not be relied upon to compensate for poor underwriting criteria (e.g., relaxing the ability to repay criteria, excessively high loan-to-value ratios or undocumented and unverified information). For mortgages, scores are used first as the gateway that determines product eligibility and then for loan pricing.
Those that cite credit scores as the reason for the mortgage meltdown demonstrate a fundamental misunderstanding about the difference between thoughtful credit underwriting and the proper use of credit scoring models.
REALITY CHECK #4: Using VantageScore will not add to consumer confusion. There has been no confusion in the credit card or auto lending space, where VantageScore has competed head-to-head with other agencies for the last decade. Not only that, but Credit Karma, Chase and Capital One, to name just a few, all use VantageScore to help their customers manage their financial health.
There are, of course, operational concerns, including the capital markets, which we’ve addressed in a recent whitepaper. Yet, with the right structure in place, competition between scoring agencies and hopefully the next modeling wizard to come along, can drive better outcomes for every link in the chain.
Director Watt: this is a golden opportunity to create a better future for America’s mortgage finance system. Embrace it.