Why millions of potential borrowers are stranded
The White House jobs report in March showed encouraging job growth a year after the first jobless claims linked to the pandemic. Still, the Biden administration says the economy remains down nearly 8.5 million jobs year over year. It would take at least until the end of 2021 – and possibly much longer – to return to pre-pandemic levels.
This means that there are still millions of Americans unemployed, and when employment is uncertain, so is income. The uncertain income of borrowers poses risk to lenders and investors, who tend to react by tightening their underwriting guidelines. It sounds reasonable – but it also has unintended consequences.
The credit box has tightened to the point where the average FICO score for all loan types is north of 750, according to ICE Mortgage Technology, and we know of several lenders whose credit overlays force applicants to have closer to ‘a 780. Meanwhile, the average FICO score in the United States is around 711. The gap between these numbers tells us that average potential borrowers – including the majority of black and Hispanic households – are being excluded from. the credit box and miss out on the lowest mortgage interest rates in history.
It’s a baffling notion for anyone who truly wants to do more than lip service to the mission of helping Americans achieve the dream of homeownership. Moreover, this is bad business; when lenders organize their pipelines to the point that they only lend to “top borrowers”, they can expect to see razor thin profit margins and high borrower turnover. After all, a person with a credit score of 780 can get a loan anywhere, anytime – something they can do whenever rates go up a quarter of a percent.
Mortgage officials I spoke to are wondering, “What am I going to do later this year and in 2022 when rates go up and cookie-cutter refits no longer fall from the trees?” Those who don’t want to spend $ 1,500 per prospect to fill the void with additional purchase loans will have to reopen their credit unions. Certainly, one way to achieve this is to enter the space of non-QM loans, but the trade-off is that non-QM loans are more expensive initially and difficult to sell. The path of less resistance is to eliminate credit overlays in order to take out more qualified mortgages for delivery to GSEs. So the question is how to do this without introducing greater risk.
One category of risk lenders should avoid is good old-fashioned fraud, and let’s be frank: bad actors come out of the woodwork in times of economic stress. There was a compelling story that made headlines in FormFree’s own backyard last month when 11 metro Atlanta residents were indicted in a mortgage scheme that defrauded several high-profile mortgage lenders as well as home construction giant DR Horton. I can think of no more perfect story to illustrate the criticality of lenders replacing paper documentation of assets, income, and unemployment with the kind of direct-source data that FormFree pioneered over a decade ago.
More generally, however, what lenders need is a better way to assess a borrower’s ability and willingness to repay a loan. A FICO score taken in isolation, especially in times of socio-economic instability, is imprecise; not all borrowers with a 700+ credit score will behave well, and by the same token, not all 600 are risky.
By supplementing traditional FICO scores with additional financial data on consumers such as assets, income, employment and liens and judgments, lenders can identify underrated or overvalued FICOs and get a more holistic assessment and based on data of each borrower’s willingness to pay. Armed with this information, lenders can improve both volume and margin by not only making more loans, but more profitable the loans.
Providing secure credit to borrowers in this segment not only creates income opportunities for lenders; it also promotes greater financial inclusion. According to the Urban Institute, “Black households have the lowest median FICO score among all racial and ethnic groups and the highest proportion of households with no credit score at all.” Hispanic households are doing a little better.
We have the tools to serve a whole segment of potential borrowers – including, disproportionately, people of color – who are “stuck in the middle” between the agency’s FICO minimum requirements and the “FICO doors” imposed by the overlays. credit from lenders. We just have to use them.