DS News

70 to expanding the scorable population. Rather than looking outside of the credit bureau files, they lowered the thresholds at which they are willing to create a VantageScore for a consumer. Whereas FICO requires at least one credit trade line open for six months or more, and activ- ity on at least one trade line within the last six months, VantageScore altered these require- ments entirely. However, this adds risky credit files to their scored population. Lower scoring standards increases the risk exposure of anyone lending based on scores because when a lender receives a VantageScore for a particular consumer, they cannot tell if the consumer had a very thin or very old credit record without actually looking into the full credit bureau file. Loosening re- quirements increases the risk exposure of anyone lending based on these scores because the reli- ability of credit risk ordering is reduced. Conversely, if a borrower doesn't have a long history of credit, VantageScore is the better fit—as it only requires one month of history and one account reported within the past two years. Because VantageScore allows a shorter credit history and a long period for reported accounts, it's able to issue credit ratings to mil- lions of consumers who wouldn't qualify for FICO scores. Borrowers that are new to credit or haven't been using it recently could benefit from VantageScore, as it might be able to prove trustworthiness before FICO has enough data to issue a rating. DIVERSE APPROACHES TO CREDIT ACCESS Not every consumer who has a credit score obtains a mortgage every year. Especially in the lower end of the credit score spectrum, many consumers are rejected for loans due to excessive debt-to-income ratios and other underwriting criteria. Of course, many consumers simply choose not to take out a mortgage because they prefer to rent or already own a home. VantageScore's approach of lower scoring standards falls short of the promise of increasing access to homeownership for millions of Ameri- cans. VantageScore claims that up to 10 million consumers previously unscored would have access to credit if standards for score creation were loosened. Quantilytic analyzed Vantage- Score, FICO, Home Mortgage Disclosure Act (HMDA), and GSE data to estimate how many new mortgages might be originated out of that population. According to VantageScore, the group of 10 million consumers with a VantageScore above 600 is referred to as "near-prime and prime." In fact, at least 2 million of the consumers are sub- prime even by VantageScore's definition as they fall under VantageScore 620. Nearly all of the remaining consumers in the expanded category have scores less than 700. As a result, FICO estimated likely mortgage origination rates by looking at the proportion of consumers in each FICO Score bucket who actually obtained mortgages in 2015, including only purchase loans as refinance customers al- ready have credit records and increased refinance volume does not constitute expansion of the bor- rower universe. Applying the appropriate origination per- centage in each score bucket to the number of newly scored consumers under VantageScore's loose requirements resulted in approximately 45,000 new mortgages per year. WHY COMPETITION MATTERS e ownership structure of VantageScore under the three CRAs creates significant barriers to true competition in the conform- ing mortgage space. While it's not normally expected for competition to increase innovation, while reducing prices, the structure of the credit scoring industry is anything but normal. VantageScore is owned and controlled by the three credit bureaus, who each, individually, have power to control access to and pricing of their data. As this data is an absolutely critical input to credit scoring models, the ownership structure of VantageScore could result in either limited or very expensive access to the data for competing firms such as FICO. Increasing the use of VantageScore, particularly through a GSE mandate, could dangerously obstruct true competition. Score competition could also push score providers to loosen standards under pressure from lenders and real estate agents looking to increase volume. is could start a race to the bottom similar to that which occurred among bond rating agencies during the housing bubble. In the years immediately preceding the crisis, an AAA rating on subprime mortgage bonds was essential for marketability; when deal arrangers could not convince one rating agency to issue an AAA, they simply went to the next agency. is "rating shopping" became the norm so quickly that all of the major rating agencies lost sight of the true risk of the bonds as they became caught up in the race for revenues. e same could happen very easily with an uncontrolled move towards multiple credit scores, particularly when lenders who do not retain default risk select the score. QUALITY OVER QUANTITY Policymakers must remember that a credit score is but one input into the underwriting decision. While lack of score can be a barrier to entry, lenders must not overestimate access to af- fordable credit that the mere presence of a score would generate. Many of the newly scored would be rejected for credit based on prudent underwriting prac- tices. While expanding the availability of credit to provide more opportunities for homeowner- ship is good, it is risky to provide people with credit they cannot handle—for both consum- ers and investors. Furthermore, to protect the financial system, it's crucial to utilize models that are reliable and accurate, rather than simply expansive. e consumer credit scoring industry has a unique structure with the three credit bureaus dominating the collection and sale of credit data while FICO provides the scoring engines that drive the vast majority of consumer credit decisions. While the three credit bureaus' joint ownership of VantageScore might provide more access to homeownership to a greater number of borrowers, it raises conflict of interest and fair competition issues that would need to be resolved to allow for true competition in credit scoring. "Lower scoring standards increases the risk exposure of anyone lending based on scores because when a lender receives a VantageScore for a particular consumer, they cannot tell if the consumer had a very thin or very old credit record without actually looking into the full credit bureau file."

• Cover