TRENDS AND TECHNIQUES IN FINANCING REAL PROPERTY
 
Credit Scoring
A major reason Fannie Mae and Freddie Mac lenders are willing
to make immediate loan decisions is credit scoring.
Credit scoring uses statistical samples to predict how likely it is that a borrower will pay back a loan.
To develop a model, the lender selects a large random sample of its borrowers,
analyzing characteristics that relate to creditworthiness.
Each of the characteristics is assigned a weight,
 based on how strong a predictor it is.
 Credit scores treat each person objectively because the same standards apply to everyone.
Credit scores are blind to demographic or cultural differences among people.
The most commonly used credit score today
 is known as a "FICO" score,
named after the company that developed it,
 Fair Isaac Corp.
 FICO scores range from 400 to 900.
The lower the score, the greater the risk of default.
According to FICO,
 the breakdown of a person's score is as follows:
  • 35 percent of the score is determined by payment histories on credit accounts, with recent history weighted a bit more heavily than the distant past.
  • 30 percent is based on the amount of debt outstanding with all creditors.
  • 15 percent is produced on the basis of how long the borrower has been a credit user (a longer history is better if there have always been timely payments).
  • 10 percent is comprised of very recent history and whether the borrower has been actively seeking (and getting) loans or credit lines in the past months.
  • 10 percent is calculated from the mix of credit held, including installment loans (like car loans), leases, mortgages, credit cards, and so on.
     
    How to increase a personal credit score
Increasing one's personal credit score is
 a long-term process.
 Following are some of the most important steps to a better credit score:
  • Pay bills on time.
    Late payments and collections can have a serious impact on the FICO score.
  • Do not apply for credit frequently.
    Having a large number of inquiries shown on
    your credit report can lower the score.
  • Reduce credit-card balances.
    Persons who are "maxed out" will find their score declines.
  • Be certain to obtain enough credit to establish a credit history.
    Not having sufficient credit can negatively impact the score.
Freddie Mac has found that borrowers
with credit scores above 660 are likely to repay the mortgage,
 and underwriters can do basic reviews of the files for completeness.
For applicants with scores between 620 and 660,
the underwriter is required to do a comprehensive review.
A very cautious review would be made for persons with credit scores below 620.
Another important scoring system,
 VantageScore,
was introduced in 2006 by the three credit-reporting agencies,
 Equifax, Experian, and TransUnion.
 All three use the same formula to calculate the score,
 unlike the FICO system,
 wherein each credit bureau uses a different formula.
 The formula differences are slight.
 The VantageScore system grades from "A" (best) through "F."
More than 200 lenders are currently testing
VantageScore as a primary scoring method,
 but none have switched from FICO yet.
FICO's stock price dropped 6 percent the day VantageScore was announced.
The credit bureaus will profit most if the new standard becomes generally accepted.
Borrowers who are quoted higher-than-market rates
 should shop among many lenders for the best terms.
If borrowers had access to their scores and more knowledge of the lending process,
they could obtain better loans.
In this endeavor, a real estate licensee can be very helpful.
While most consumers have full credit bureau reports
 used by lenders to evaluate credit risks,
approximately 54 million Americans
 (young people, recent immigrants, or newly divorced or widowed consumers)
 have no reports on file.
Because these situations make it difficult to qualify for mortgages,
FICO has developed a new credit score program that lenders may elect to use.
 This program evaluates "nontraditional" data,
such as how well consumers handled payday loans and retail payment plans.
 The FICO score will also review how responsibly individuals used their checking accounts'
 overdraft protections.

Web Link:

H.S.H. Associates, financial publishers: mortgage information:

www.hsh.com

Is credit scoring valid?

With credit scoring, lenders can evaluate millions of applicants consistently and impartially on many different characteristics. To be statistically valid, the system must be based on a big enough sample. When properly designed, the system promotes fast, impartial decisions.

FICO has recently completed NextGen, designed to more precisely define the risk of borrowers because it analyzes more criteria than the old model. Using the new model, lenders can evaluate credit profiles of high-risk borrowers in terms of degrees, rather than lumping them into the same category.

What are the future uses of credit scoring?

Many experts believe that residential lending will begin to use credit scoring the same way it is used in automobile financing and consumer loans. Freddie Mac is currently conducting a pilot program with large lenders. Interest rates on home mortgages may be based on the credit score. Today's "6 percent mortgage" may be tomorrow's "5¾ percent for A+ borrowers, 6 percent for A, and 6¼ percent for B+."

Web Links:

Fannie Mae home page:

www.fanniemae.com

Freddie Mac home page:

www.freddiemac.com

FHA Single Family Insurance page:

www.hud.gov/offices/hsg/sfh/insured.cfm

Federal Reserve Board:

www.federalreserve.gov

U.S. Federal Trade Commission:

www.ftc.gov/

U.S. Department of Veterans Affairs:

www.va.gov/