Changes in how the nation's leading mortgage-financing companies calculate credit scores could come by the end of the year, potentially qualifying millions of Hispanics for mortgages that are now out of reach for them.
Mortgage financing giants Fannie Mae and Freddie Mac will decide by the end of the year whether to adopt new credit-scoring algorithms – basically new formulas – that would make it easier for people with non-traditional credit histories or those with a lack of credit to meet the requirements for a home equity loan.
One credit agency estimates that 2.4 million more Hispanics and African Americans could qualify for a mortgage if Fannie and Freddie update their models.
The decision will come at a time when America’s home ownership rate, which is at 63.4 percent, has hit a 48-year low. The Hispanic home ownership rate hit a 14-year-low last year, at 45.4 percent.
Hispanics are fueling American home ownership growth. New Hispanic households accounted for 40 percent of U.S. household growth in 2014 – the largest share of any ethnic group in the U.S, according to the National Association of Hispanic Real Estate Professionals. Yet, the most significant barrier keeping Hispanics out of the housing market is the tight access to mortgage credit access.
The problem, experts say, is that Hispanics don’t like to take out loans or owe money on credit cards and tend to pay bills in cash because they are afraid of ballooning debt.
“Hispanics tend to have thin credit profiles, not necessarily bad, but very little credit,” said Gary Acosta co-founder and CEO of NAHREP. “Seventy-percent of Hispanic home-buyers are first-time home buyers that don’t have a lot of wealth and don’t have a long history working with banks.”
The current FICO credit-scoring system, which has been around since 1956, is primarily used by banks and lenders to determine how risky or likely someone is to pay off their debt. The number is traditionally based on on-time payment history, how much debt a person has, length of credit history, type of credit, and – to a smaller degree – how often lenders take a look at a borrower’s credit history.
The problem, many Hispanic real estate professionals and experts say, is that the current FICO credit score is outdated and is no longer an accurate representation of whether someone is credit-worthy or responsible enough to pay back a huge loan like a mortgage.
The current score relies on pre-2008 recession data and consumer spending habits, putting an emphasis on lengthy repayment histories of credit. These days, more and more Americans don’t own a traditional credit card, have never owned a home and are using cash to pay bills and purchase items.
According to the latest government figures, 26 million Americans are considered credit invisible – those with no credit history at any of the three major credit bureaus. Additionally, the report found that about 15 percent of black and Hispanic consumers are considered invisible. Another 19 million Americans, including 12 percent of Hispanics, are considered “unscorable” because of limited credit histories.
Enter VantageScore. Since 2007, the three major credit-reporting bureaus have been using VantageScore as an alternative to the FICO credit score but it has virtually not been used at all by mortgage lenders. FICO remains the industry standard. VantageScore claims it casts a wider-net of bill-payment history and also can generate a credit score for those with thin credit profiles.
“We score people after one month of credit usage. [With] FICO, you have to use credit for 6 months,” Barrett Burns, CEO of VantageScore, told Fox News Latino. “Often people think that a new scoring consumer is a higher risk than a longer-term borrowing customer. We tested that theory. That math showed us that the first year default rate of new scoring consumers is basically identical to the first year default rate of conventional longer-term borrowers.”
The company believes its credit score model, which is being considered by Fannie Mae and Freddie Mac, would allow 7.6 million new customers (including 2.4 million Hispanics and African Americans) to qualify for a mortgage.
“First- and second-generation Latinos tend to be very conservative, they don’t borrow a lot of money, they tend to be cash based,” Burns said. “They avoid credit. So they are getting penalized for being prudent. What I mean by that is that they are infrequent credit users. So our model, because it does score in the first month of usage, and looks back 24 months, picks up an enormous amount of infrequent credit users and therefore doesn’t penalize people who are prudent in their credit usage.”
Lynnette Cox, founder of themoneycoach.net, said companies like VantageScore would benefit Latinos and other minority groups who tend to not deal with banks for their money. VantageScore uses rent and utility payments in its algorithm, if they are reported by the landlord or utility provider.
“One huge indicator is a person’s rent payment,” Cox said. “If someone’s been making on-time rent payments for seven years, chances are the person will likely be able to make a mortgage payment.”
Cox also believes remittances, the amount of U.S. dollars sent from Hispanic families to relatives in Latin America should be taken into account in credit scores because they are an indication of how much cash families have and what they are spending their money on. Remittances to Latin America and the Caribbean set a record high in 2015. About $65.3 billion was sent from Hispanic families in the U.S., according to the Multilateral Investment Fund.
“The idea is that this money is showing you there’s a huge amount of dollars at play here. Are they looking at that as cash availability?” Cox said. “You could assess a person’s financial wherewithal by looking by how much they are sending to their countries.”
Experts expect Fannie Mae and Freddie Mac to adopt newer credit score algorithms in the next few months but would not be surprised if the decision was delayed. The costs of having to change banking software and train its staff on the new formulas has factored into the slow approach they’ve taken thus far, Cox said.
“It is vitally important,” Cox said of updating credit score models. “These are the largest players in the mortgage game, and it’s time.”