Credit scores to be revised amid soaring mortgage defaults

Found in the LA Times this article from Ken Harney

Reporting from Washington —

With foreclosures soaring — and homeowners with unblemished payment histories abruptly walking away from their houses with no warning to lenders — the two major producers of credit scores have begun changing how they evaluate consumers' risks of default. The revisions could affect you the next time you apply for a loan.

In late October, both Fair Isaac Corp., developer of the FICO score, which dominates the mortgage field, and VantageScore Solutions, a joint venture by the three national credit bureaus and marketer of the competing VantageScore, outlined modifications they were making to handle the vast credit disruptions caused by the housing bust, the recession, high unemployment and behavioral changes by consumers.

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Overall, credit industry experts agree, consumer creditworthiness has deteriorated in the U.S. since 2006 — especially among what used to be considered the credit elite, people with the highest scores. For example, a study this year by VantageScore found that the probability of serious delinquency — defined as nonpayment for 90 days or more — had increased 417% among "super-prime" borrowers between June 2007 and June 2009. Default risk during the same period rose 406% for the second-highest-rated category of "prime" consumers, and nearly doubled for those at the "near prime" scoring level.

The driving force behind the score revisions, according to Sarah Davies, VantageScore's senior vice president for analytics and research, is the "significant change in consumer credit repayment behavior" that began during the housing bust and recession.

Not only are borrowers who previously were rated outstanding credit risks far more likely to default today, she said, but many homeowners are defying long-standing credit industry assumptions by going delinquent on their first mortgage payments while continuing to pay their credit card balances and second mortgages on time. Strategic defaults, or walkaways, by high-score borrowers also have been an unexpected development, she said.

To adjust its statistical models to these new realities, VantageScore says it conducted intensive research on 45 million active credit files obtained from the databases of its joint venture partners, Equifax, Experian and TransUnion. The research examined the same files — with personal identifiers removed — during set time periods between 2006 and 2009 to capture emerging behavioral patterns associated with defaults on various types of credit accounts. The resulting VantageScore 2.0, which is expected to be rolled out nationwide to lenders in January, focuses on the subtle warning signs of credit stress that might have been missed earlier and penalizes or rewards consumers with higher or lower risk scores than they would have received before.

Joanne Gaskin, director of mortgage scoring solutions for Fair Isaac, said her company's new FICO 8 Mortgage Score was based on similarly exhaustive research into consumer credit behavior changes over the last four years. When used by a lender to rate the risk of new applicants or existing mortgage customers, Gaskin says, the Mortgage Score is likely to be 15% to 25% more accurate in detecting signs of future default compared with the standard FICO model.

Though she would not discuss proprietary details about the early warning signs the new score monitors, Gaskin gave an example of how the new score might work: Say a borrower with a 720 FICO score has average balances on a first mortgage, home equity lines and other accounts that are higher than norms pinpointed by the revised scoring software. A 720 FICO is considered a good score by most mortgage lenders, often qualifying for favorable rates and terms. However, the same applicant might rate just a 680 FICO or lower if the lender used the new Mortgage Score. The lender would then have a choice: Reject the applicant, quote a higher interest rate on the mortgage or require a larger down payment.

Gaskin said the reverse could also occur: The FICO 8 Mortgage Score could come in higher than the standard FICO — indicating lower risk for the future — in situations where formerly troubled borrowers manage to put themselves back on a healthier credit track.

Experts in the credit industry say the new scoring efforts by Fair Isaac and VantageScore should prove to be a net positive for the housing and mortgage industries if they can do what they claim: spot subtle risk patterns and nascent hints of improvement.

But as a mortgage applicant you should know that your next score might not look anything like the score you thought you had. You might end up getting a better deal — or worse than you wanted — when lenders quote you rates and terms.

A Peek inside the Credit Scoring Engine

On May 7th. 2010, I wrote about how little credit it takes to have a great score. Today we look into this a little further, and contrast two different credit profiles. It’s all in the management!
Here is an example of damaged credit:
Total Credit Lines in history: 6. “DLA”=Date of Last Activity
1. Open Collection $481 Balance
2. Auto Loan. $16574 High Credit Limit. 62 Months old. $0 Balance, Paid off 6 months ago. No lates.
3. $146 High Credit Limit. Paid Charge off. 46 Months ago.
4. Medical Collection. $100 High Credit Limit. Paid 47 Months Ago.
5. Bank Credit Card. $600 High Credit Limit. 40 months Old. 0 Balance. DLA 39 Months ago. No lates.
6. Store Credit Card. $0 Balance. 12 Years Old. DLA 9 years ago. No lates.
The Credit score is 643. Although one collection and one charge off were paid off several years ago, the open collection is still damaging the score. Another factor is the ratio of good-to-derogatory credit items. In this case, addressing the open collection (in the right way), creating occasional activity on a new line of credit or two and on trade lines #5 &/or #6 will help to re-build this score over time.

Let’s compare this example with another.
Total Credit Lines in history: 4.
1. Secured Credit Card 72 Months old. High Credit Limit $300. Current Balance $204. DLA 1 month ago.
2. Secured Credit Card 72 Months old. Reported Stolen, $0 Balance. DLA 48 months ago. (Re-issued as account #1.)
3. Credit Card 3 months old High Credit Limit $1000. Balance $0. DLA 3 months ago
4. Charge Account. 48 Months Old. High Credit Limit $550. Balance $0. DLA 4 months ago.
The credit score is 783! This shows that if obligations are met, it is not necessary to have several different types of credit, more than a couple of trade lines, frequent activity, or even more than modest amounts of credit available to achieve an outstanding score.

Can a young person achieve an excellent credit score?

With banks now expecting a middle score of 720, or even 740 to extend the best pricing or terms to you, it is now important to build up your credit profile to achieve these levels. Not only that, but many lenders don't want to see much variance between the scores from Equifax, TransUnion and Experian. A mix of 673, 735 and 751 would not be considered excellent because of the one score below 680, even though the mid score is well above 720.
Common knowledge is that it takes years and a mix of several different kinds of trade lines to build up a high score. We'll see by the examples below that this is not necessarily true.
It is true that to have little credit history is equal to having bad credit. But it is not as hard as one might think to build up a great score from nothing. Of course, you must always pay on time, and have no derogatory items (such as collections, judgments or charge-offs) to maintain a high score. The examples shown below have done that.

Now let's look at 2 actual real-life examples:

Example #1:
Total number of Trade Lines is three.
1st one is a credit card , opened 7 months ago. The High Credit (amount available) $500. The balance is 63, the minimum payment is $25.
2nd is an auto loan, opened 42 months ago. High Credit $3000. This account was satisfied in 18 months and has 0 balance.
3rd is a $1000 credit card opened 66 months ago. It has a 0 balance.

Pretty minimal number of trade lines and amount of borrowing power, yes? What would you guess the credit score to be? Maybe 680 at best?

Example #2:
Number of trade lines is two.
1st one is a credit card opened 5 months ago. The balance is $63, the minimum payment is $25.
2nd one is an auto loan. It was opened 33 months ago. High credit was $5836.
It has a 0 balance.The "months reviewed" is 2. This means the loan was payed off early.

Do you think that just 2 trade lines could achieve a 680 score? Maybe?

Both accounts have had 2 inquiries in the last 12 months.

Both of these accounts have Key Factors impacting the score of:
1. Length of time Accounts have been established
2. Length of time revolving accounts have been established
3. Too many inquiries in last 12 months
4. Proportion of balances is too high on bank revolving or other revolving accounts

Now what do you think?

(drum roll, please)

Score #1: 786

Score #2: 741

Interesting, isn't it?

What have we learned?

Credit reports all show the same Key Factors items 1-4 above,
even if you have the highest possible score!

To have an excellent score:

It is not necessarily to have five or more trade lines of different types.

It is not necessary to have shown an ability to handle 5 and 6 figure high balances and 4 figure payments.

It is not necessary to have 6 or more years of credit history.

Owing a small percentage of your available credit has a positive impact on your score. (FYI, under 30% for credit cards is best.)

And by the way, our examples are 23 and 22 years old!

Go forth, use credit accordingly, and prosper.