Light at the End of the Tunnel? New Credit Score Models Are Coming

For every 15 people banks approve for mortgage loans, one applicant gets turned away. That one person is likely to be a member of a minority group. And the barrier could be a credit score.

But at least some good news is on the horizon: a credit scoring system designed to recognize the real-life financial activities of regular people.

What Most Credit Scores Ignore

Consumer Reports recently ran an article by a hopeful Texas home buyer. When the would-be buyer tried to get a mortgage preapproval, the company said no. The applicant’s credit score (647) wouldn’t fly with the lender.

Lenders use FICO® credit scores — combined with proof of income, assets, and related factors — to predict an applicant’s power to pay off a mortgage in the months and years after closing.

But a FICO® credit score is imperfect at best. It can be unforgiving, and not particularly fair. It’s supposed to reflect an applicant’s handling of savings and credit. Most notably, the “Classic FICO” score examines these factors:

  • The breadth of credit accounts a loan applicant holds. Algorithms used to set FICO® scores look at the total available credit the potential borrower currently has. They also add up the length of time the applicant has managed those accounts — even accounts that have no recent activity. The time an applicant has kept accounts going will impact 15% of a credit score.
  • A steady balance payment history. A record of making payments on time is vital. This one adds up to 35% of a credit score, according to Consumer Reports.
  • A consumer’s ratio of spending to total available credit. Using more than 30% of an available credit line on any given card creates a “credit utilization” issue. And “credit utilization” counts for almost a third of what goes into a FICO® score.

All of the above makes sense to a lender who is trying to judge the way a mortgage loan applicant will act in the future. But there might be many good things in an applicant’s financial history — such as a long record of on-time rent payments — that aren’t counted at all, even though they’re obviously relevant to paying for housing.

Facing Up to Bias in the “Classic” Credit Score

People in racial minorities will have a fairer shot at mortgage approvals with the new system. That’s because it faces up to the bias in the scoring method, which favors current homeowners over people who are trying to get a foot through the door.

The Urban Institute says 15% of African American first-time mortgage applicants who were denied loans could have been approved — if only their scores had acknowledged their regular rent payments. And even more Latinx applicants could have purchased homes.

When applicants with borderline credit scores do manage to qualify for loans, they’re considered riskier, so they are likely to receive higher-interest loans, and be saddled with private mortgage insurance payments.

For more information about racial bias in the mortgage application process, see this article: We Know It. We Denounce It. So Why Does Bias in Lending Persist?

“A More Inclusive Approach” by 2025

Loans backed by Freddie Mac and Fannie Mae will shift to new credit scoring models, to better assess applicants who don’t fit the classic FICO® model. The Federal Housing Finance Agency (FHFA) is mandating the use of a new set of standards: FICO® Score 10 T and VantageScore 4.0. The FHFA oversees the major conventional lending companies.

What’s different about FICO® Score 10 T and VantageScore 4.0? They account for longer periods of credit use. And now, rent, phone bills, utility payment histories — all of these financial activities will be counted in an applicant’s credit profile.

How else will the FICO® Score 10 T and VantageScore 4 models support home loan applicants? They’ll no longer ding the applicants for old, paid-off bills that went into collections at some point. And they will be more forgiving to the applicant who has medical debt.

The FHFA first announced the validation and approval of the new credit score models for use in conventional mortgage loans in October 2022. Sandra L. Thompson, director of the FHFA, says adopting the new models will take time, as the mortgage industry adapts. The new scoring system is expected to roll out in late 2025.

For the past two decades, Fannie and Freddie have used “Classic FICO.” But changing the system will be worth the effort. It will ensure “improved accuracy and a more inclusive approach to evaluating borrowers,” Thompson explained.

The shift to FICO® Score 10 T and VantageScore 4 will also help mortgage brokers approve more loans. In a time when applications are down due to rising interest rates, this will help the industry along with helping first-time buyers. And this leads us to another point. If more applicants head for conventional loans to get the new scoring models, we may find the FHA and other government-backed programs adjusting their scoring methods, too.

What Can Hopeful Buyers Do Before 2025?

Already, there are ways to get regular rent, phone, and utility bill payments counted in a personal credit profile already — although they do have some limitations.

Equifax®, Experian™ and TransUnion® are the three major credit reporting companies. Each offers the consumer one free credit report a year. After getting their scores, how can consumers raise them—say, from fair to good, or from good to very good? Lenders generally consider a FICO® score of 670 to 739 as good. A very good score, in the 740 to 799 range, gives an applicant freedom to choose even better mortgage terms.

Experian™ has a feature called Boost. This feature takes into account a range of monthly bill payments. But payments through popular apps still don’t count. The consumer has to put the payments on a credit card or use direct drafts from their bank accounts. Also, only participating property management companies mesh with Experian’s Boost feature.

Then there’s TransUnion®. For a yearly fee (currently $24.95), the company integrates the eCredable feature. This allows phone, utility, and cable bills to count in a credit score. The company says its product can help people with thin or no reported credits histories.

As for Equifax®, it integrates the Bilt Rewards app for residents of participating rental properties. The app allows the payment of rent as well as reporting it for credit.

Need to tune up your credit profile? See our Five-Point Credit Repair Plan.

Reform Is Overdue, But on the Way!

Credit scores stop many responsible credit users from buying homes. The current revamping of credit scoring models offers hope. And hope cannot come too soon for many potential buyers.

Supporting References

Lisa L. Gill for Consumer Reports: Applying For A Mortgage? Here Are 5 Hacks to Improve Your Credit Score (May 2, 2023; citing information from the Urban Institute, research by the Consumer Financial Protection Bureau and the National Consumer Law Center, and a report by the Federal Reserve).

The Federal Housing Finance Agency (FHFA), News Release: FHFA Announces Validation of FICO 10T and VantageScore 4.0 for Use by Fannie Mae and Freddie Mac (Oct. 24, 2022).  

The Federal Housing Finance Agency (FHFA), Fact Sheet: FHFA Announces Validation and Approval of FICO 10T and VantageScore 4.0 Credit Score Model (Oct. 24, 2022).

And as linked.

Photo credits: Pixabay and Cottonbro Studio, via Pexels.