Are you having trouble getting a home loan because you have no suitable credit history? Has your credit activity been dormant for a long enough time that lenders can't properly evaluate your risk?
The FICO credit-scoring standard used by Fannie Mae and Freddie Mac requires that potential borrowers have a credit account open for at least six months to be able to assess credit risk properly. Without that background, you are "credit invisible." You may be responsible with money and pay rent, utilities, and cell phone bills on time – but those aren't considered in evaluating mortgage loan applications.
According to data from the Consumer Financial Protection Bureau (CFPB), approximately 26 million people are considered to be credit invisible. Nearly 19 million people are similarly shut out of mortgages because they have "stale credit" – their credit history hasn't had enough recent activity to give an accurate picture of creditworthiness according to the FICO system.
The Federal Housing Finance Agency (FHFA) has been considering a revamp of the scoring system used by Fannie and Freddie. FHFA has been evaluating a switch to the newest FICO scoring version (FICO 9), the latest version of the competing VantageScore system (VantageScore 3.0), or a combination of the two. (MoneyTips offers free VantageScore credit scores to members.) The FHFA was expected to decide and implement the changes sometime in 2018, but this deadline has been delayed until 2020.
That's not soon enough for Congress and the Trump administration. President Trump signed legislation back in May intended to accelerate the process. It requires Fannie and Freddie to consider using new credit scores or recently updated ones in their decision-making process, bringing the currently credit invisible back into consideration for mortgages.
The intent is to help credit-invisible borrowers or those with stale credit secure mortgage loans if they meet enough of the remaining risk criteria. You still must give banks credible evidence that you are likely to repay the loan, such as having a suitably low debt-to-income (DTI) ratio.
Who would take issue with that? Critics have raised concerns that the legislation directs the FHFA toward the VantageScore model, which is jointly owned by the three primary credit bureaus (Experian, Equifax, and TransUnion). VantageScore allows a credit score to be calculated without requiring a full six months of credit data to analyze.
Theoretically, a change to allow VantageScore in Fannie and Freddie's decision-making process could increase competition by challenging the dominant FICO scoring system. It could also backfire by giving the bureaus incentive to artificially cut prices for VantageScores, increase sales of credit reports to compensate, and potentially lower standards to increase business.
The whole argument revolves around standards – are they too tight, or just right? Backers of the bill assume that many creditworthy Americans are being shut out unfairly because of arbitrary rules. Critics take the slippery-slope argument, saying that the industry is allowing greater risk in an attempt to drum up more business. They believe we'll eventually slide back into the situations that caused the housing crisis and triggered the Great Recession.
We'll know more once the FHFA decides how to enact the new legislation and we see how mortgage lenders react. Until then, if you're one of the credit-invisible masses, you may want to take initial steps to build your credit by opening one or two credit accounts, making small purchases on each, and paying the bills off in full every month. You can soon build a credit history to allow you to qualify for a mortgage – and you'll be showing responsible credit practices regardless of FHFA actions.
You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.