FICO Says It Cracked the Strategic Defaulter Code
Credit unions servicing a significant number of mortgages might benefit from a new tool to help determine which mortgage holders were at the highest risk for choosing to default, FICO said.
Strategic defaults have become a significant problem for mortgage servicers and holders and particularly for FICO, parent of the FICO credit score. Research has shown that the borrowers most likely to walk away from their mortgage loans tend to be otherwise sterling examples of good credit and money management practices.
The company found that strategic defaulters tend to be more savvy managers of their credit than the general population, with higher FICO scores, lower revolving balances, fewer instances of exceeding limits on their credit cards and lower retail credit card usage.
Lenders have traditionally used the degree of home price depreciation as a basis for predicting strategic defaults; however, new FICO Labs research indicated that borrowers whose houses have lost the most value are only twice as likely to default as those whose houses have lost the least value.
"Through the use of custom analytic models, FICO Labs researchers have demonstrated the ability to identify borrowers who are over 100 times more likely to default strategically than others," FICO said.
"Before mortgage servicers can work effectively with potential strategic defaulters, they must first be able to identify them," said Andrew Jennings, chief analytics officer at FICO and head of FICO Labs. "Our new research shows it is possible for servicers to find those at greatest risk of strategic default, both to prevent losses and to prevent borrowers from making a decision that will damage their credit future."
Credit union members have not been as eager to strategically default on their mortgage loans because credit unions are more willing to work with the borrower to resolve the situation, according to industry sources, but the phenomenon has hit some CUs.
FICO has already introduced the product with the largest national mortgage servicing firms.
Jennings shed some light on the research FICO has done in the area.
"There appears to be a correlation between people who might have only been at an address for a couple of years and their willingness to walk away," Jennings said, adding that people who are looking seriously at walking away from a mortgage often take steps to increase their supply of available credit before they do it.
FICO is rolling the new product out to servicers first because servicers are its natural target market, he explained. "This is a product for after the loan is booked," Jennings said, "not as much as part of the underwriting process."
Consumers at risk for walking away from mortgage commitments have been harder to identify since, as a whole, they usually have better than average credit patterns.
And what should servicers do once they have identified a borrower with a high potential to default? A FICO white paper entitled "Predicting Strategic Defaults" suggested, "Because those at risk of strategic default often have high credit scores and care very much about maintaining that status, pre-delinquent communications should also emphasize negative ramifications." It urged servicers to remind borrowers how much more expensive and difficult it might be to have a dramatically lower credit score after a default. And then there are the potential legal costs.
"Servicers should also make sure borrowers know they will use all available means to collect the debt," FICO wrote in the white paper. "Sometimes, borrowers are misled by the casual discussion of strategic default in media and blogs on the Internet. It's important for servicers to make the policies and intentions clear."