Homeownership could become more accessible thanks to new FHFA rules

The two main companies that produce credit scores are FICO and VantageScore. MoMo Productions

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• Conforming mortgage lenders will start using FICO 10T and VantageScore 4.0 scoring models to evaluate borrowers.
• These newer scoring models utilize alternative credit data, such as rent payment history, and use a trended data approach.
• The FHFA will also remove upfront fees for certain loans, which should reduce costs for borrowers.

The way mortgage lenders evaluate a borrower's creditworthiness is set to change, and it could remove some hurdles to homeownership, particularly for low-income households or people of color.

In October 2022, the Federal Housing Finance Agency announced that lenders would soon need to change the ways they look at credit when approving borrowers for conforming mortgages.

The FHFA is the federal agency that oversees the two biggest providers of liquidity in the mortgage market, Fannie Mae and Freddie Mac. These entities are responsible for setting the standards conforming loans need to meet, including minimum acceptable credit scores.

One of the biggest changes the FHFA made is that Fannie and Freddie will soon exclusively purchase mortgages that utilize two newer, updated credit scoring models that take a more holistic look at a borrower's credit situation. This expands the pool of potential creditworthy borrowers and makes homeownership more accessible for many of those who have had trouble qualifying through traditional means.

What is a credit scoring model?

You don't just have one credit score. There are many different types of consumer credit scores, and they all have different formulas they use to translate the information in your credit report into a number that signals how much of a risk you present as a borrower.

The two main companies that produce credit scores are FICO and VantageScore, and both of these companies have multiple scoring models that each have their own nuances. 

Using updated scoring models can improve access to mortgage financing

Mortgage lenders, as required by the FHFA, have been using older FICO scoring models for many years, which has made it difficult for those who don't have traditional credit histories to qualify for a mortgage.

But soon, lenders will be asked to start using two newer scoring models: the FICO 10T and the VantageScore 4.0. The FHFA describes these models as "more inclusive" than the FICO scoring models that lenders have been using for the last two decades.

"Requiring both credit scores, when available, will result in more borrowers that can be evaluated by [Fannie Mae and Freddie Mac] than a single score alone, which will improve their management of credit risk while also responsibly and sustainably expanding access to credit for borrowers with less robust credit histories," FHFA director ​​​​​​Sandra Thompson said in an October speech announcing the changes.

The FHFA's goal is to expand access to mortgage financing without increasing the number of defaults. According to FICO, implementation of the FICO 10T could increase mortgage approval rates by 5% without additional risk.

How FICO 10T and VantageScore 4.0 differ from older scoring models

Traditionally, building credit has been a tricky catch-22 where establishing a credit score requires convincing a creditor to lend you money, which they often won't do if you don't already have an established positive history of borrowing from other creditors.

But it's possible that will soon be a thing of the past, as more lenders and credit reporting agencies are open to the idea of using other forms of financial data to establish a consumer's level of credit risk.

The new scoring models that Fannie Mae and Freddie Mac will require mortgage lenders to use — the FICO 10T and the VantageScore 4.0. — have the ability to consider non-traditional forms of credit, like rent or utility payment history, when calculating a consumer's score.

Christina McCollum, Washington Regional Manager for Churchill Mortgage, says this is a big win for consumers.

"Considering the alternative is taking out debt to provide the agencies a history of their creditworthiness, this is a significant development for potential homebuyers and increases access to the American dream," McCollum says.

These scoring models also utilize trended data. This means that instead of looking at a single snapshot of your credit use, your score is generated based on a longer time frame and looks at your overall habits, like whether your balances trend up or down or if you're paying off your credit card every month.

Pricing benefits for first-time and low-income borrowers

Another change the FHFA is implementing is the elimination of upfront fees on certain loans, which could translate into lower interest rates for borrowers of those loans.

Loans that won't be subject to upfront fees include:

• First-time homebuyer loans for borrowers who earn no more than the area median income or less than 120% of the median income in high-cost areas
• Fannie Mae HomeReady and Freddie Mac Home Possible loans, which are aimed at low-income borrowers
• Fannie Mae's HFA Preferred and Freddie Mac's HFA Advantage loans, which are available through housing finance agencies
• Single-family loans supporting the Duty to Serve program, which serves low-income households

The FHFA estimates that around one in five borrowers would be eligible for this pricing benefit.

Another change the FHFA made that could potentially reduce costs is lowering the number of credit reports lenders are required to order on conforming loans from three to two. 

Currently, mortgage lenders pull credit reports from each of the three major credit bureaus and look at the scores on each of those reports.

"A benefit of accepting a bi-merge is less cost to both the consumer and mortgage company by not paying for three separate credit reports," McCollum says. "The downside is that the current standard would use the middle score numerically to determine the credit score used, but now there will only be two, so it increases the impact of your lowest score on your ability to qualify."

Why these changes are good news for borrowers

Getting a mortgage without a traditional credit history is typically difficult. This is a problem that disproportionately impacts Black and Hispanic borrowers, who are more likely than white borrowers to be "credit invisible," according to the Consumer Financial Protection Bureau.

Implementing a credit scoring model that can utilize alternative forms of payment history gives the credit invisible the ability to qualify for a mortgage where they previously would have been denied. 

In her speech, Director Thompson noted that the FHFA is only now beginning a "multi-year implementation phase," meaning borrowers who would benefit from these changes won't get to take advantage of them just yet. But if you're thinking about buying in a few years, this could make getting a mortgage easier and potentially less expensive.

But other entities are working on expanding access to homeownership as well. Last month, Fannie Mae announced new underwriting enhancements that make it easier for those with no credit score to qualify for a mortgage using alternative data.