85% of good borrowers with low FICO scores will never get a mortgage
Lenders must deny mortgages to good borrowers to prevent too many deadbeats from getting mortgages and destabilizing the housing market.
Environment is stronger than will power. — Paramahansa Yogananda
When you were in high school, did your parents ever caution you about the company you keep? The people you share common interests with can be either a positive or a negative influence on your decision making. They can lead to to success, or they can lead you astray.
When lenders want to evaluate a potential borrower, they don’t interview friends, but they do examine the financial characteristics of a borrower’s life, and they make determinations based on the historical behavior of others with the same characteristics. That’s the whole point of a FICO score.
The Fair Isaac Corporation built a successful business around classifying and categorizing large groups of people based on similar financial characteristics. If people in your group default at higher rates than other groups, your FICO score will suffer, irregardless of whether or not you think or act like those people.
It’s not possible for credit underwriters to look into your heart or determine whether or not you have upstanding morals. They aren’t interested in you as an individual. Lenders can only go by what others with your financial characteristics have done, and if others like you tend to default on their debt obligations, then you are deemed a risk as well.
Drawing lines in the shades of gray
In any group of potential borrowers, there are some that will default, and there are some that won’t. Despite default rates north of 50%, there are still some subprime borrowers dutifully paying their mortgages. Should we bring back subprime lending because the 50% who would make it are currently being denied access to a mortgage?
The job of credit underwriters and actuaries is to properly classify people into the appropriate groups, then draw a line across the shades of gray. For the sake of bank solvency, this line will always be drawn conservatively. Obviously a 50% or greater default rate experienced in subprime is far too high, but what is an acceptable rate of mortgage default?
According to a recent survey, FICO scores between 640 and 620 default about 15% of the time. Most lenders cut off in this range, and it can be argued that a 15% default rate is much too high and perhaps the lenders should tighten further.
But even if only 15% of borrowers with FICOs between 640 and 620 default, that means that 85% do not. If the FICO score requirement is raised to 640, then 85% of creditworthy borrowers will be denied credit. Although the percentage of good borrowers denied mortgages drops as the FICO score goes down, no matter how low you go, some creditworthy borrowers will always be denied credit. That’s the price they pay for the company they keep.
By JOE LIGHT, Nov 2, 2015
… despite low mortgage rates and government efforts to expand mortgage access, borrowers with anything but strong credit scores are still relatively absent. …
Real-estate-data firm Black Knight Financial Services said that in August 21% of mortgages to buy homes–as opposed to refinances–went to borrowers with credit scores below 700. That was down from 24% in August 2014 and from 40% in August 2005.
The lack of activity from lower-credit borrowers presents a puzzle for federal regulators and mortgage lenders, which have worked for nearly two years to ease mortgage access.
Overall purchase mortgages rose 11% in July and August versus a year earlier, while the volume of purchase loans to sub-700 borrowers actually fell 5%, Black Knight said.
This should not be a surprise at all. In fact, this is a feature of Dodd-Frank. Regulators wanted lenders to stop making bad loans and pass the risk on to others like they did during the housing bubble, and lenders complied. The lack of lending to borrowers with low FICO scores was inevitable given the intent of Dodd-Frank. This isn’t a bug — it’s a feature.
By JOE LIGHT, August 10, 2015
… Some lenders are still afraid of getting sued or of taking another hit to their reputations.
Mostly, it’s the fear of getting sued. It’s hard to imagine banks tarnishing their reputation worse than they already have.
The GSEs all demand that lenders buy back their bad loans if the borrower defaults shortly after origination. Though lenders lobbied to curtail or remove this protection, so far both Edward DeMarco and later Mel Watt resisted their attempts to push losses on to the US taxpayer.
On Thursday, Fannie Mae CEO Timothy J. Mayopoulos said that Fannie and the FHFA have made great strides toward working with lenders to ease their concerns about being hit with penalties by Fannie years after they’ve made a loan.
Problem is, Fannie isn’t the only entity that lenders have to answer to. In the past few years, lenders have been under scrutiny from the Justice Department, Consumer Financial Protection Bureau and dozens of state attorneys general and lawmakers for alleged mistakes and abuses before, during and after the financial crisis. Some lenders think the scrutiny is overzealous and have pulled back from making certain loans as a result.
It isn’t these groups that are the problem. Dodd-Frank gave significant powers to borrowers to sue lenders for bad behavior. If a lender doesn’t properly evaluate a borrower’s ability to repay the loan, the lender can be sued by the borrower for relief. The fear of borrower lawsuits is what really prompts lenders to toe the line.
“When I meet with lenders, it’s very clear that there’s great concern about the legal and regulatory enforcement from any number of players at the federal and state level. It’s not something that we at Fannie Mae control,” Mr. Mayopoulos said. He said that the actions have had a “substantial effect on the mindsets of lenders, at least as they express it to me.”
During the housing bubble, the bogus financial innovation embraced wholeheartedly by lenders centered on shifting risk from the originating lender on to other parties. For lenders it was the best possible arrangement because they could originate any loan some investor was stupid enough to purchase.
Prior to these “innovations” lenders used to keep the loans they originated on their own balance sheets, so they were keenly aware of the need to properly vet a borrowers ability to repay because if they didn’t, the lender lost their own money.
The elimination of the failed innovations of the housing bubble restored the healthy fear of loss lenders used to operate under. The fear of loss is the essential check and balance in the banking system, and it shouldn’t be viewed as an impediment to the housing market. In truth, It’s the bedrock of the market’s stability.