If you haven’t heard already, big changes are coming to the credit reporting space. On October 24, 2022, the Federal Housing Finance Agency (FHFA) announced that conventional mortgages will soon use two new credit scoring models and bi-merge credit reports.
This announcement has naturally spurred many questions among mortgage professionals:
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- How do the new credit scoring models differ from Classic FICO?
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- How will these changes impact borrowers’ mortgage eligibility?
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- When will these changes take effect?
In this article, we’ll break down the most important details of the FHFA’s announcement. After that, we’ll explore the implications of these changes on borrowers and lenders alike.
Table of Contents
On-Going Updates
- Update Added 10/11/2023. See “Impact to Technology & Recommendations from MISMO” for new information.
- Updated Timeline. See “When Will These Changes Take Place” for the latest implementation dates.
- Fannie Mae revised “Partner Playbook for the Credit Score and Credit Reports Initiative” Available November 1, 2023.
- Update Added 2/29/2024. See “Implementation Timeline Update” for new information.
What Are the New Credit Scoring Models?
For nearly two decades, Fannie Mae and Freddie Mac required mortgage lenders to use the Classic FICO credit scoring model. But soon, they will start requiring FICO 10T and VantageScore 4.0 in its place.
These credit scoring models stand out from Classic FICO for their:
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- Implementation of alternative credit data – VantageScore 4.0 takes into account applicants’ payment histories for rent, utilities, telecom payments, etc. In turn, it can help mortgage applicants with limited loan and credit card experience generate credit scores.
- Trended data – Classic FICO can only show a snapshot of an applicant’s credit activity on the day their credit reports were pulled. In contrast, FICO 10T and VantageScore 4.0’s trended data can shed light on 24 months of credit history, making it a much more comprehensive metric of creditworthiness. While the GSEs have previously used trended data, they have not used a trended data score.
Based on rigorous testing conducted by the FHFA, these two new credit scoring models “exceed required thresholds for accuracy, reliability, and integrity.”
What Differentiates These Two New Credit Scoring Models?
While these new credit scoring models share some similarities, they also differ in some important ways. Most notably, VantageScore 4.0 will only require one month of credit history to generate a credit score. FICO 10T, on the other hand, will still require at least six months of credit history.
While lenders will be required to use VantageScore 4.0, they can extend mortgages to applicants who may otherwise be credit invisible. According to VantageScore, 37 million Americans who don’t have FICO credit scores do have VantageScore credit scores.
What Are the New Credit Score Requirements?
Historically, mortgage lenders have been required to pull tri-merge credit reports for conforming mortgage loan applications. These credit reports contain credit scores from all three of the major credit bureaus (Experian, Equifax, and TransUnion). Lenders typically use the middle credit score to determine a borrower’s eligibility, mortgage rate, and loan terms.
Once the new bi-merge requirement takes hold, mortgage lenders will only need to order credit scores from two of the three credit bureaus. Credit bureau selection will be left up to mortgage lenders’ discretion.
So, which of the two scores will be used to make mortgage eligibility determinations? The GSEs have yet to make a decision. They may decide to:
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- Take the average of the two scores
- Use the higher score
- Use the lower score
Impact to Technology & Recommendations from MISMO
Currently, most of the mortgage industry’s trading partners utilize the MISMO Credit Transaction v2.3.1 to transmit a digital credit report. While this standard is widespread, it’s no longer recommended by the Mortgage Industry Standards Maintenance Organization (MISMO) and is no longer supported. The v2.3.1 was adopted 20 years ago, and many changes have occurred since its inception.
In response to the new Credit Report initiatives by the FHFA, MISMO is recommending credit trading partners move to v3.4 or later. It has been stated that v3.4, v3.5, and v3.6 have no appreciable differences for the trading partners. There are many advantages for the trading partners to make this move, including:
- Utilizing a compatible MISMO Standard Reference Model enables the consolidation of development efforts across various MISMO transactions, promotes code reuse, and simplifies processes. This is expected to result in reduced maintenance time and fewer overall defects.
- MISMO v3.x supports standard Schema Validation (over the older DTD technology). Schema validation allows for reduced development time and more straightforward verification between trading partners. Other benefits include data quality improvements and maintenance cost reduction.
- Over the last 20 years, many enhancements and changes to credit reporting have been incorporated into the model. These changes include Trended Data, Decoding Comment Codes (mainly focused on Bankruptcy, Forbearance, Loan Modification, Deed in Lieu, and Loan Forgiveness), Documenting Inquiry Posting Type (such as Hard and Soft), Documenting Permissible Purpose Type (such as Extension of Credit and Written Instructions). Many of these enhancements have been added to MISMO v2.3.1 transactions as Custom Extensions. Extensions often have implementation variations between different trading partners, causing confusion and the potential for data misrepresentation.
- MISMO v3.x has expanded to support a JSON Representation of the MISMO Transactions, allowing for more efficient and easier-to-implement integrations between trading partners. In addition, a MISMO API Community of Practice (CoP) has created standards around integration implementation. While these new features are optional, they offer a broader array of options when using MISMO 3.x.
MISMO will be sending an industry survey soon to assess the readiness of the industry to move to version 3.x for the credit transaction.
How Can These Changes Benefit Mortgage Applicants?
The new credit scoring models and credit score requirements have the potential to make homeownership more accessible for previously underserved markets. This is because they:
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- Expand access to credit to people with limited credit histories – Since lenders can now look at VantageScores, in addition to FICO scores, borrowers with less than six months of reported credit history may be able to qualify for mortgages.
- Extend access to credit to people with strong alternative credit data – 26 million Americans don’t have enough traditional credit data to generate a credit score. This may be because they’re young, they just recently moved to the United States, or they simply prefer using cash and debit cards in place of credit.
Since the new credit scoring models take into account alternative credit data (rent, utilities, telecom payments, etc.), they can give these otherwise credit-invisibles a chance to show off their on-time payment histories and enhance their mortgage eligibility.
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- Have the potential to reduce the racial homeownership gap – Black and Hispanic Americans are more likely to have no or low credit scores. They’re also less likely to own their homes. According to a Pew Research Center study, 58% of Black-led households and 52% of Hispanic-led households rent their homes, compared to just 27.9% of non-Hispanic, white-led households.
While FICO 10T only uses traditional and trended credit data, VantageScore 4.0 also factors in alternative credit data. Thus, VantageScore 4.0 can help more Black and Hispanic borrowers build their credit histories, qualify for home loans, and close this historic homeownership gap.
Based on these benefits, more borrowers should now more than ever have the opportunity of attaining the American Dream.
How Can These Changes Benefit Mortgage Lenders?
Many borrowers can expect to gain from the FHFA’s credit scoring changes, but what about mortgage lenders?
Lenders can also look forward to what’s to come. After all, the credit scoring updates have the potential to:
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- Impact credit reporting costs – With the bi-merge credit report requirement, mortgage lenders may be able to cut down on their credit reporting costs. Lenders can then pass on these cost savings to their borrowers and make their mortgages more affordable.
However… Lenders who continue pulling three credit scores (Classic FICO, FICO 10T, and Vantage 4.0) may actually find that their credit reporting costs go up. The impact to credit reporting costs is still unknown and will depend on your unique processes and procedures. - Use more precise risk assessments – By taking into account trended data and alternative credit data, FICO 10T and VantageScore 4.0 provide a more accurate look into an applicant’s credit risk. Thus, they may help mortgage lenders make better lending decisions and improve their portfolios.
- Impact credit reporting costs – With the bi-merge credit report requirement, mortgage lenders may be able to cut down on their credit reporting costs. Lenders can then pass on these cost savings to their borrowers and make their mortgages more affordable.
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- Promote healthy competition among the credit bureaus – Since mortgage lenders can choose which credit bureaus they want to use for their bi-merge reports, the credit bureaus may have to improve their offerings to get chosen consistently. This competition may inspire more innovation, improving the credit industry for everyone involved.
- Promote healthy competition among the credit bureaus – Since mortgage lenders can choose which credit bureaus they want to use for their bi-merge reports, the credit bureaus may have to improve their offerings to get chosen consistently. This competition may inspire more innovation, improving the credit industry for everyone involved.
Are There Any Drawbacks to These Changes?
Despite the potential benefits, there are some downsides that may arise from these changes. For instance, if the GSEs decide to use the lower of the two credit scores, this may negatively impact some borrowers’ interest rates, loan terms, and Loan Level Pricing Adjustments (LLPAs). According to a report from Equifax, VantageScore discovered that variations in credit bureau data can impact around 15% of consumers’ credit scores by 20 points. Thus, if this credit score selection option is chosen by the GSEs, it could lead to the unnecessary denial of up to 2.8 million credit applicants.
Beyond that, some stakeholders believe that bi-merge credit reports will provide a less complete picture of borrowers’ creditworthiness than tri-merges. The resulting data blind spots may impair the accuracy of mortgage lenders’ decision-making.
How Can Mortgage Lenders Share Their Feedback?
At various points in this process, the FHFA has requested feedback from stakeholders about its proposed changes. For instance, during the first quarter of 2023, the FHFA administered a survey that received nearly 1,000 responses. At this time, it also reiterated its commitment to ensuring a smooth transition and set a tentative timeline for these changes’ implementation.
On September 11, 2023, the FHFA entered its “Public Engagement Phase.” During this phase, the FHFA plans to host forums, listening sessions, and targeted discussions. According to FHFA Director, Sandra L. Thompson, “We want to hear from market participants and impacted stakeholders to ensure a smooth transition that minimizes costs and complexity.” The FHFA intends to use this feedback to fine-tune its implementation timeline and address potential challenges.
The FHFA is hosting some initial listening sessions in the coming weeks. At Certified Credit, we encourage our customers to participate in the evolving discussion. If you want to share your thoughts with the FHFA, you can by reaching out to CreditScores@fhfa.gov by September 25, 2023. You can also keep track of future announcements on the Fannie Mae Credit Score Transition Page and Freddie Mac Credit Score Transition Page.
When Will These Changes Take Place?
No matter where you stand on the merits of the FHFA’s changes, they are scheduled to take effect. Oringally, the bi-merge requirement was initially expected to take effect during the first quarter of 2024, but the FHFA has since pushed back this deadline.
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- The new credit scoring models are expected to be required by the fourth quarter of 2025.
The bi-merge requirement was initially expected to take effect during the first quarter of 2024. The FHFA has since pushed back this deadline, and it’s expected to take place later in 2024.
While today’s mortgage applicants won’t experience the impacts of these changes, aspiring homeowners who plan to enter the housing market in the coming years will.
February 29, 2024 Implementation Timeline Update
After several months of gathering stakeholder feedback, the FHFA announced that it will align its implementation timelines for the bi-merge requirement and new credit scoring model requirements. Both of these changes are expected to take effect in Q4 2025.
By coordinating these changes’ timelines, stakeholders can enjoy a more efficient transition. According to FHFA Director Sandra L. Thompson, “Synchronizing bi-merge credit reporting with the implementation of the new credit score model requirements will reduce complexity for market participants, which is a key objective of our transition efforts.”
To facilitate an even smoother transition, the Enterprises plan to publish VantageScore 4.0 historical data sooner than anticipated—this data should be available in the early part of Q3 2024, as opposed to the original publishing date of Q1 2025. This expedited timeline was created in response to stakeholder feedback. Many stakeholders believe that reviewing this historical data ahead of time will help them update their systems and workflows in preparation for the transition.
Historical data for the FICO 10T model should be provided soon, too, though the FHFA and credit bureaus are still organizing this data and determining a publishing date. In the meantime, the FHFA continues to invite stakeholder input.
New Fannie Mae “Partner Playbook for the Credit Score and Credit Reports Initiative”
Fannie Mae has revised the Partner Playbook for the Credit Score and Credit Reports Initiative. The update incorporates details about FHFA’s final rule on the Enterprise Regulatory Capital Framework (ERCF) issued on November 21, 2023.
Additionally, it provides insights into how the public can engage in stakeholder forums and adjusts the timeline to account for the postponed milestones associated with the originally proposed bi-merge credit reporting option, now scheduled for 4Q 2023 and 1Q 2024.
How to Help Your Mortgage Applicants Strengthen Their Credit Scores
In light of these changes, you may be wondering how you can help your borrowers bolster their creditworthiness under the new credit scoring models. It ultimately comes down to providing them with actionable credit education.
Despite these updated regulations, the same credit-building and credit-boosting strategies still apply. These tactics include:
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- Making debt payments on time
- Maintaining a low credit utilization ratio
- Keeping old credit card accounts open when possible
- Avoiding unnecessary credit applications
- Getting experience with both revolving and installment credit accounts
- Disputing errors with the credit bureaus
Beyond that, you can recommend that your aspiring mortgage applicants ensure their rent, utilities, and telecom payments get reported to all three credit bureaus so they have strong alternative credit data to bolster their credit scores. All three credit bureaus have assured that only positive alternative credit data will make it onto consumers’ credit files. You can also emphasize the importance of practicing positive credit management long before applying for a mortgage to improve trended data.
Qualify More Borrowers With Certified Credit
In summary, the FHFA’s update to credit reporting models and credit scores is going to have noteworthy impacts on the housing and mortgage markets. If all goes according to plan, these changes should improve mortgage lending accuracy, inclusion, and innovation.
If you want to prepare your mortgage lending business for these upcoming changes, Certified Credit can guide you every step of the way. Our mortgage lending solution consultants can help your business gear up for what’s to come and capitalize on worthwhile growth opportunities. In addition to our workflow consulting services, we also provide:
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- Affordable credit reports
- Automated lead generation and borrower retention tools
- Automated prequalification
- Automated verification of income and employment
- Automated undisclosed debt monitoring
- Flood zone determinations
- Fraud and risk support
- Settlement services
- Cascade Verification of Employment
- Cascade Alerts
Want to set your mortgage lending business up to succeed amidst these credit reporting changes? Schedule a credit consultation with the Certified Credit team today.
