Lenders gauge mortgage risk

0 Comments | Insight on the News, April 22, 1996 | by Stacie Zoe Berg

Credit scoring, which uses statistical analysis to assess the likelihood that a borrower will pay back a loan, is making its way into the marketplace. The Federal Home Loan Mortgage Corp. -- one of the major mortgage buyers in the United States -- recently recommended that private lenders use the new tool when deciding whether to approve mortgage loans. The mortgage industry expects the system to become the norm if the current programs prove accurate.

Traditional underwriting has been guided by the three C's:

* Collateral, measured by a loan-to-value ratio;

* Capacity, measured by overall income and expense profiles and confirmed, in part, by debt-to-income ratios; and

* Credit reputation, the determination of a borrower's willingness to repay.

Credit scoring, developed by Fair, Isaac and Co. in San Rafael, Calif., and CCN-MDC in Atlanta, clarifies the last category. The scores, which are complied at the three major credit-reporting bureaus -- Equifax, TRW and Trans Union -- ignore demographic information such as nationality, race, ethnicity, age, sex, marital status and religion, as well as income. Instead, data from various credit sources -- banks, stores, car dealerships -- are pooled in "blind" fashion -- employees at the bureaus are unaware of what information gets what weight. The scores provide an index of risk.

"In and of itself, [the score] is not a deal maker or a deal killer," says Brian Chappelle, staff vice president at the Mortgage Bankers Association. Although there is no magical "passing" grade, risk increases dramatically with Fair, Isaac scores below 620.

Would-be borrowers can receive low scores for numerous reasons -- there are about 35 of them -- ranging from "amount owed on accounts is too high" to "too many inquiries last 12 months." The categories assessed include payment performance, use of credit and file history. Past payment performance is the most predictive of these characteristics and carries the most weight. Young borrowers or immigrants won't necessarily receive low scores because of their relatively new credit histories; rather, they are judged against those with similar credit histories using predictive patterns of credit risk.

The system isn't perfect, says Florence Clark, senior vice president at Credit Bureau Services, who says she has seen many credit files filled with inaccuracies leading to poor scores. She advises everyone to check their files at all three bureaus, even if they aren't in the market to borrow. Clark also advises borrowers to cancel credit cards they don't use because they're considered potential debt. Similarly, borrowers should avoid opening new credit-card accounts because recently opened accounts hurt scores.

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Other credit discrepancies occur for various reasons. May be a due date has changed and it appears as a late payment or bills were returned because a change of address was not recorded by the billing office. Card users who have fallen behind in payments but since have made good on their accounts should note that credit companies don't necessarily record the debt "paid in full." Be sure accounts are up-to-date. Clark also points out that borrowers have a right to be interviewed during this credit-scoring process.

"We have been recording credit scores on mortgage loans for some time now, but we don't use them as the centerpiece for our underwriting," says Marc Smith, president of Crestar Mortgage Corp., in Richmond, Va. Nor is Crestar using credit scores on community-outreach programs. Those programs will be underwritten in the traditional way using Federal Housing Authority, state and local housing programs. "Long term, I think these programs will come under the use of credit scoring," Smith says.