Credit Scoring: A Crucial Lending Tool In A Competitive, COVID Environment

Heading into the second quarter of 2021, it’s clear that the year has brought with it both significant change (new administration in Washington, host of new regulators with a sea of change in perspectives and priorities) and a continuation of many trends, including COVID-related forbearance activity.  Despite originating some $4 trillion in loans in 20201, lenders and borrowers do face challenges as we begin to transition from a refinance-dominated market to a more balanced mix, with strong growth in purchase loans predicted.  One of those challenges will be how to deal with some unique credit and risk scenarios.  As lenders modernize their platforms and processes, focus on improving customer experience and engagement, they need to help educate their borrowers on the realities of credit scoring.  Both lender and borrower should also take advantage of the available technological tools that can lead to better credit and risk-based outcomes.

A Look at the Landscape

Before we get to those solutions, let’s get a clear picture of where the housing and real estate finance markets currently stand.  The most immediate and obvious issue keeping executives up at night right now are the 2.5 million mortgages currently in forbearance.  According to the latest figures2 from the Black Knight Financial Services, 2.3 million mortgages are in some state of forbearance.  That figure has ticked down over the past few weeks, a positive sign to be sure.  Another bit of good news is the high level of equity the nation’s homeowners currently hold.  CoreLogic reports3 that homeowners have gained almost $1.5 trillion in equity since Q4 2019 – a 16% annual average increase.  On the economic front, the national unemployment rate continues to hover just above 6%4, but with states reopening everywhere and the vaccine rollout ongoing, it looks like we’re primed for a robust recovery.

Despite all that good news, there are some concerning data points in the housing market.  Specifically, housing inventory continues to languish, with the National Association of REALTORS noting5 that active inventory has fallen by 54% over the past year.  It will continue to and has driven home prices sky-high and forced homebuyers into fierce competitive situations with cash-rich buyers.  More on that in a moment.  Finally, credit availability is at its lowest level since 2014, with the Wall Street Journal reporting6 that roughly 70% of mortgages in 2020 went to borrowers with credit scores of at least 760, up nearly 10% in just one year.  This stat in particular should be a wake-up call for both originators and borrowers, a clear reminder of the importance of credit score monitoring and having a clear understanding of how credit scores are calculated and used.

How is Forbearance Impacting Credit Scores?

As we start to move beyond the COVID pandemic, some normalcy will return to the industry. However, lenders and servicers have a responsibility to continue to take care in how they deal with and report on consumers who are still suffering from the crisis.

For instance, as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act, servicers may not report a mortgage borrower delinquent if their account is in forbearance as a result of COVID-19.  As lenders and servicers return to something approaching “normal” operating procedures, it will be very important to have a detailed knowledge about the forbearance status of all borrowers within their portfolios.

In fact, at Credit Plus we’re already fielding calls from clients requesting this information.  Fortunately, we can verify whether an account is in forbearance and provide detailed information, including the last date a mortgage payment was made by the borrower.  This is often the result of manual work that may take slightly longer than some of our other automated offerings, but it is essential information for lenders and servicers.

It is good news that forbearance figures continue to trend downward, as it signals a return to a non-COVID world, but it also means that the next few months will be critical, as the industry’s credit/risk mechanisms work to get a handle on consumers’ forbearance statuses.  That uncertainty carries some level of risk.

Lenders need to work with their compliance teams to obtain guidance on the types of information that can be requested from the consumer and what information can be reported to the credit bureaus.

Educate, Educate, Educate

As we just mentioned, credit is as tight as it has been since 2014, cash-rich buyers and competitive bidding abound and borrowers simply must prioritize maintaining a solid and healthy credit profile.  It starts with education – many prospective borrowers simply have many misconceptions about what a credit score is, how it is calculated, and how it is used.  A true lending partner (not just a one-time, transaction-focused originator) can play a big role in helping demystify credit scoring.  For instance, one of the most common questions LOs hear is “why is the credit score you pulled different than what I found online?”

In the Internet/information age, borrowers can do more than search houses and rates online.  However, when they get a score from a credit card company or other third-party source, it may not line up with the scoring model that Fannie Mae/Freddie Mac are using for their programs.  Loan officers should inform their borrowers that each of these online services uses a different scoring model than the mortgage industry, weighing credit in their own way.  Some of the online sites include utility or even subscriptions like Netflix in their scoring models, and that may be something that is used more widely in the future; however, the GSEs dictate which models are currently used in loan origination. 

Further, many borrowers need clarification on what the credit report and score is actually measuring – the model that we use in the mortgage industry was designed to reliably predict whether a borrower would become more than 90 days delinquent on an account within the next 24 months and is one of the primary ways lenders can fairly gauge the probability (along with other factors) of a borrower’s ability to pay their mortgage, based on how they’ve managed credit in the past.

Helpful Technology Tools

The Internet/information age has also allowed for the construction and dissemination of many technologies that lenders and borrowers can utilize to better manage their credit.  Twenty years ago, most borrowers had virtually no way to know what their credit was until a lender pulled it.  In 2021, no borrower should be surprised by their score.  Credit analysis tools like our CreditXpert® Wayfinder™ are available to assist lenders with their borrowers.  This credit score analysis tool quickly and easily generates a detailed analysis of the applicant’s credit score.  Further, our “What If” simulator allows you to simulate changes to the applicant’s credit file and predicts the score that may result from those changes. This credit score analysis technology lets loan officers generate a separate analysis for 1, 2 or 3 bureaus, build an analysis for a co-borrower, and easily view or print a report from history.

Lenders should also remember that, again, if their borrower uses a third-party tool to monitor their score, the only score that matters in mortgage lending is the one used by the GSEs.

Non-QM Lending: Seeing the Whole Picture

One of the fastest-growing segments of the mortgage industry over the past few years has been the non-QM market.  A recent article in HousingWire noted that non-QM lending is likely to rise sharply as the economy recovers.  Many potential non-QM borrowers don’t have a simple W2 income, so lenders need to utilize a variety of other ways to confirm income, assets, and employment.  That includes tools like The Work Number®, a solution offered through Equifax Workforce Solutions, which provides fast, electronic validation of employment and income.  Sometimes the solution has to be manual – Credit Plus provides clients a uniform, auditable process that includes obtaining email verifications from employers who cannot be reached via phone.  For self-employed borrowers, lenders can verify using P&L statements prepared by a CPA, instead of 4506-Cs, tax returns and bank statements.

After the upheaval of the last year, lenders providing non-QM loans must go beyond the top-line numbers to make sure they see the full picture, the whole credit/risk profile of their borrower.

For both lenders and borrowers, the future is uncertain, but full of opportunity.  Credit scores, however, will remain key in determining creditworthiness.  Lenders looking for customers-for-life should help educate their borrowers, utilizing the best tools available from expert industry partners dedicated to helping expand homeownership opportunities.

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Bibliography

1 – “Rate lock data suggests $4 trillion in 2020 mortgage origination volume” HousingWire, 11/2/2020. https://www.housingwire.com/articles/rate-lock-data-suggests-record-4t-in-2020-mortgages/#:~:text=Rate%20lock%20data%20suggests%20%244%20trillion%20in%202020%20mortgage%20origination%20volume%20%2D%20HousingWire&text=Rates%20jumped%20to%203.17%25%20last,refi%20candidates%20in%20a%20year.

2 – “Mortgages in forbearance see steepest drop-off in 6 months” National Mortgage News, 4/9/2021. https://www.nationalmortgagenews.com/news/mortgages-in-forbearance-see-steepest-drop-off-in-6-months?utm_source=newsletter&utm_medium=email&utm_campaign=NMN_Daily_Intraday+News_04092021_forbearance%2B%27-%27%2B04092021&bt_ee=WbTz7apVrpI1P3NSaETx7oq35OuNby4Kz40ewaLQUt4%3D&bt_ts=1617987649530

3 – CoreLogic – Homeowner Equity Insights.  Accessed 4/8/2021. https://www.corelogic.com/insights-download/homeowner-equity-report.aspx

4 – “Monthly unemployment rate in the United States from February 2020 to February 2021” Statistica.  Accessed 4/8/2021. https://www.statista.com/statistics/273909/seasonally-adjusted-monthly-unemployment-rate-in-the-us/

5 – “Weekly Housing Trends View — Data Week April 3, 2021” Realtor.com, April 8, 2021. https://www.realtor.com/research/tag/housing-inventory/

6 – “Need a Mortgage Loan? Good Luck. Lenders Are Tightening Standards.” Wall Street Journal, April 2, 2021. https://www.wsj.com/articles/the-mortgage-market-is-roaring-but-lots-of-people-cant-get-a-loan-11617355802