How to Use the Best Predictive Tools to Revive Mortgage Lending
The economic recession and corresponding real estate market crisis have caused credit unions and other lenders to dramatically tighten their mortgage underwriting standards in order to protect their business and stay afloat in these tough times.
Yet while their actions are helping to control risk and losses, they are also making the recovery even harder for borrowers. Many consumers, even ones with high credit scores, can't secure new mortgages. As a result, housing supply in the marketplace today continues to considerably outweigh demand, and the real estate market and macro economy haven't been able to rebound to normal, stable levels.
How have tougher standards changed mortgage originations for credit unions? And what new best practices can credit unions adopt to gain more confidence in their mortgage lending and potentially serve more consumers? Recent research we have done reveals answers to both questions.
Credit union lending trends can be seen in our newest "FICO Score Trends Service Insights Report," in which we crunched credit risk trend data from a nationally representative sample of nearly 9 million consumers over a five-year period from 2005 through 2010. And validations of new, more predictive scores show how credit unions can improve lending programs with more focused analytics.
In short, strong trends are emerging that show that credit unions are originating mortgages for consumers with the highest FICO scores only. More than 30% of all mortgages originated between May and July 2009 were to consumers with FICO scores of 800 or higher-and almost half of all mortgages in the same period went to a score of 780 or higher. Compared to 2005, when roughly the same percentage of new mortgages were given to consumers with scores of 720 or higher, the latest figures represent a 60-point rise in less than five years.
In addition, just 10.9% of customers with a score lower than 660 were able to secure a new mortgage in mid-2009, compared with 20.5% the year before and 31.1% in 2005.
Of course, it's hard to fault credit unions for tightening their lending standards. Targeting lower-risk members makes good business sense in a shaky economy, and the data show that the strategy has lowered 60-day delinquencies over 12 months from 2.8% of mortgages booked in 2005 to just 0.9% of new mortgages in 2009. This drop has helped to lower credit unions' costs of doing business and servicing accounts and improve their bottom lines.
But while credit unions can feel good about these gains, the side effects of their strategies have begun to surface. Consumers who do not have a top FICO score, especially more traditional high-risk consumers like first-time homebuyers, are having more trouble than ever securing a mortgage. And because of that, full-scale real estate market and broader economic recovery has been slow to materialize-stricter lending standards are creating a credit gap for millions of Americans.
How can credit unions simultaneously gain more confidence in their newly originated mortgages and potentially take on more business and help the economy while keeping losses and risk under control?
One of the critical things credit unions can do is improve their risk assessment early in the originations process. While most credit unions today employ the use of a risk assessment score, many would benefit from leveraging a score built specifically for mortgage risk. Adopting powerful and targeted risk assessment tools can help credit unions reduce losses and originate profitable loans.
A new study we performed shows the losses that can be saved by using a mortgage-specific score. Our study looked at the results of using the FICO 8 mortgage score-built specifically to predict mortgage default risk--compared with the FICO 8 score, which assesses a borrower's general credit risk. Assuming an industry standard loss of $50,000 for each loan that goes bad, we found that a typical credit union originating 500,000 mortgages a year using a score cutoff of about 620 could save $62 million more than they could by using the general-risk score. Assuming the same industry standard loss figure, we also found a typical credit union originating 130,000 mortgages annually to first-time homebuyers using a score cutoff of 640 could save more than $7.5 million in that period using the score.
As this shows, there is tremendous power in mortgage-specific analytics and predictive tools. Through new features such as upgraded scorecard segmentation, refined risk performance characteristics, mitigation of authorized user abuse, continued regulatory compliance and minimized minor collection and public record infractions, these tools are rapidly gaining interest and proving their worth. They also are delivering the confidence credit unions need to continue originating loans not only to members with top credit scores but also potentially to others as well.
Using better predictive and decision-making tools will allow credit unions to be more prudent in their risk management practices while still originating better mortgages and quite possibly loosening their standards to service more members. This can only be good for business, and good for the economy as a whole.
Joanne Gaskin is product management director at FICO. She can be reached at 415-446-6000 or firstname.lastname@example.org