A change is coming to the credit scoring models used by mortgage lenders for most home loans*, and this could have an impact on consumers. Although the changes won’t come into play until late next year, it’s not too early to learn about the new model and get ahead of the learning curve.
What’s Changing?
Mortgage lenders will now use VantageScore 4.0 and the newer FICO Score 10T (instead of Classic FICO) when qualifying borrowers for a home loan.
This reduces lending costs, because borrowers have to pay for each credit report. Additionally, backers of this plan argue that this will encourage competition among the three credit reporting agencies, which will lead to better service to consumers.
How Does the Current Credit Scoring Model Work?
Currently, most mortgage lenders use the Classic FICO score when evaluating a borrower’s ability to repay a loan. FICO is the more established credit scoring model and has been in use since 1989. It was developed by the Fair Isaac Corporation to introduce data-driven decision making into home lending and remove biases based on gender, race, marital status, and other prejudicial factors. The new FICO 10T is a more comprehensive model that, according to FICO, can expand mortgage approval rates by 5%.
Unlike FICO, VantageScore was developed by the three credit reporting agencies: Experian, TransUnion, and Equifax. It was created in 2006 with the goal to help more people develop a credit score, particularly historically marginalized groups, like minority and lower-to-middle income Americans. VantageScore requires only one month of credit activity (instead of FICO’s six months), which means consumers can build a score faster. VantageScore also weights credit factors differently than FICO. (These factors include payment history, available credit, balances, and more.)
Using both these scores is expected to benefit borrowers because lenders will get a fuller picture of their credit histories. In particular, borrowers with a shorter credit history will benefit from the VantageScore, since it takes less time to build a credit score.
How Do Credit Reporting Requirements Impact Mortgage Approvals?
An individual’s credit score varies depending on which credit reporting agency’s information is used. Currently, lenders are required to pull credit reports from all three credit bureaus: Experian, TransUnion, and Equifax. If all three scores differ, the lender uses the median (middle) score. If one score differs, they go by the two scores that match.
With the new changes coming, lenders will have the option to pull only two credit reports, though three can still be used. If the lender pulls all three of a borrower’s reports, then information from all three must be considered in evaluating the borrower’s creditworthiness. If a lender opts to use two reports, the borrower doesn’t get to choose which reports will be used. That decision will be left to the lender.
Some lenders will likely continue to require three reports, because they see that as a way to minimize their risk. But lenders using two reports will reduce borrowing costs, which may be a selling point for homebuyers shopping around for the best loan.
Why Are These Changes Happening?
The federal agencies that regulate home loans are driving these new requirements because they believe it will be better for both consumers and lenders. Specifically, the agencies want to:
Promote healthy competition among credit bureaus
Increase access to credit for consumers
Provide better assessments of credit risks
Include more sources of payment data, like rent and utilities, which could help consumers with limited credit histories
What Do Borrowers Need to Do to Get Ready?
If all this sounds a bit confusing, don’t panic. Ultimately, these are behind-the-scenes changes that won’t radically alter the process borrowers follow to get a loan. As lenders, credit agencies, and mortgage professionals work through the details of implementing this new system, just keep your focus on the tried-and-true advice for achieving a good credit report, like:
Paying your bills on time
Paying more than the minimum due whenever possible
Keeping your credit utilization below 30%
Checking your credit reports annually to look for mistakes
You can also talk to your loan officer about what these changes mean, especially if you’re planning to buy a house late next year.
*Applies to loans backed by Fannie Mae and Freddie Mac. These changes do not apply to government-sponsored loans, including FHA, USDA, and VA loans.
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