Anyone who has tried to buy a home in the last two years knows that credit requirements have tightened quite a bit. Even people with decent credit are having a hard time getting approved for mortgage loans. And, thanks to the latest credit scoring product from FICO, it might become even more difficult to qualify for a home loan in the coming year.
FICO 8 Mortgage Score
In October 2010, the Fair Isaac Company revealed its new Mortgage Score, based on the FICO 8 credit scoring formula. It is worth noting that FICO is always tinkering with its credit scoring formula, adding more factors, and increasing the sophistication of the measure. While we have a general idea of what is included in a FICO score, the truth is that the actual formula is a closely guarded secret. And, in addition to the more generic FICO score that we are all used to hearing about, FICO offers a number of different scoring products. These scoring products include those that rate depositor behavior for banks, as well as the FICO 8 Mortgage Score.
There are also many other types of credit scores, such as the VantageScore, and those provided by other fintech companies, such as Credit Karma and Credit Sesame.
As you might gather from the name of this score, the Fico 8 Mortgage Score is meant to help lenders figure out what sort of default risk you pose to them. On its web site, FICO describes the power of the FICO Mortgage Score:
The score includes 17 distinct scoring models, increased from the 12 included in the base FICO® 8 Score. This allows for more refined risk assessment of mortgage consumers that’s better tuned to reflect mortgage-specific risk performance. Five segments evaluate the future risk among mortgage consumers, including first mortgages.
It appears that, in response to the mortgage market crisis, FICO has been working on a way to help lenders decide whether or not help borrowers with loan modifications, as well as figure out which first mortgage borrowers are likely to default. One of the areas of especial concern to mortgage lenders is the growing segment of the market interested in strategic default.
Strategic default is a conscious decision made by a homeowner to walk away from a mortgage that is underwater. These defaults often take lenders by surprise, since borrowers do not show classic signs of being on the verge of mortgage default. They meet all of their other financial obligations and often have good credit. However, the point of a strategic default is to cut one’s losses, feeling that a home has depreciated so much in value that it isn’t worth to try and overcome the negative equity.
One of the main duties of the FICO 8 Mortgage Score will be to help lenders more accurately predict which borrowers could be a strategic default risk. Don’t ask me what models the Fair Isaac Company would use to make such predictions, but apparently, there are some tell-tale financial behaviors that could indicate that someone with otherwise good credit might end up employing a strategic default in certain circumstances. I wonder if the locale of the home you are trying to buy is included in the calculation as well.
Do Mortgage Lenders Use Other Credit Scores?
Yes, they do. In fact, while the Fico 8 Score was released almost a decade ago, most lenders still use the FICO 2, 4 and 5 scores when processing mortgage applications. Most lenders use the residential mortgage credit report (RMCR). The RMCR combines data from all three major credit bureaus, strips out duplicate details, and creates a merged credit report.
Lenders will then look at the three different credit scores and use the middle of the three scores (not the average). So if you have three credit scores of 690, 713 and 725, the score the lender would consider would be 713.
The RMCR will also contain your historic employment and residence histories, and potentially other information to help the lender gauge risk. This could include reports on past legal judgments, bankruptcies, foreclosures, loan defaults, and similar information.
Predicting Consumer Credit Behaviors
This development is just one of a large number of efforts to further reduce consumer credit behaviors to numbers that can provide at-a-glance assessments for financial service providers. With technology in the digital age providing the ability to collect a great deal of information about you almost instantly, it is little surprise that more factors, from income estimates to deposit behaviors to what you say about money on social media to where you bought lunch yesterday, are being considered as part of yourconsumer credit risk profile. Indeed, we may be moving toward a system that can provide real-time updates to your credit score.
Ensure Your Credit Report & Score Are Error-Free & Up to Date
Lenders and credit bureaus are becoming more sophisticated at assessing consumer risk. Because of this, your credit profile is more important than ever, if you are going to apply for a loan. And unfortunately, major data breaches have made it easier than ever for identity thieves to steal your personal data and open up lines of credit in your name.
This is why it is essential to monitor your credit reports to ensure there are no problems with your credit. Should you find any errors with your credit reports, you should fix them immediately to prevent damage to your credit score. You can get copies of your credit report for free from AnnualCreditReport.com and from other companies.
Finally, it is a good idea to check your credit score every so often. Keeping track of your credit score will alert you to any changes and help you know if you are moving in the right direction. Thankfully, you can check your credit score for free with one of several companies, including Credit Karma, Credit Sesame, and others. Many banks and credit card companies also offer this service to their customers.
Some companies, such as Fico, do not offer free credit scores. But you can often find Fico coupon codes to save money if you decide to buy your credit score/report from them.
Finally, some people choose to pay for a credit monitoring service in conjunction with an identity theft protection policy. This can be a good way to not only monitor your credit report for errors, but to also gain protection against identity thieves.