In late September, Fannie Mae made one of the most significant changes in decades to how it evaluates the creditworthiness of applicants for home mortgages. As part of the underwriting process, it will now review trended credit data, which is effectively the repayment history of how a particular consumer services their debt.
In the short term, this change could benefit a significant number of Americans that apply for a mortgage. The introduction of this new way of assessing consumer credit data comes at a time that is especially relevant given the recent report by the Federal Reserve that over the last decade there has been a decline in mortgage lending opportunities for minorities.
In the long term, it could have a larger significance, encouraging more consumers to manage their credit wisely and transforming the very way lenders assess risk. However you look at it, the change will be transformative to the mortgage industry and further illustrates the important role the credit industry plays in the U.S. marketplace.
In 2003 consumers began to obtain their annual credit report at no cost. Millions of Americans became familiar with the vital role a credit report plays in determining their ability to obtain financing. The report, which each of the three major credit reporting agencies maintain independently, typically shows how much a consumer has borrowed, their total available credit, how much debt they have outstanding, and any delinquency in payment history. A snapshot of a moment in time.
The traditional credit report has been fairly static, as they do not include other key data sets that provide major insight into a consumer’s ability and willingness to pay their bills on time, which has become more important as the country has moved closer and closer to a cashless economy. The inclusion now of up to a 24-month transaction history will add a new level of sophistication that will provide better ways to assess a consumer’s ability to afford, manage and repay loans.
Another way to think of the change is if you were to imagine having a photograph and then discovering video. All of sudden, the credit report has become more dynamic and lenders and other credit providers move closer to a 360 degree view of a consumer, which will benefit both consumers and lenders.
This “new view” will be translated in a couple of ways with consumers holding credit cards and other revolving monthly accounts largely falling into two categories: transactors and revolvers. “Transactors” are those consumers who pay their credit card accounts in full or in large part every month, while “revolvers” are those who only pay the minimum amount due.
Historically, credit reports couldn’t differentiate between those two types of consumers because reports only showed a snapshot in time. As a result, a consumer who paid their balance in full every month might appear to have the same level of creditworthiness as one who only paid the minimum owed, if both reports were obtained at the same time.
The actual creditworthiness of those two consumers, however, could be dramatically different. Research has shown that borrowers who pay off their credit card every month are 60% less likely to become delinquent than borrowers who make only the minimum payment each month.
Trended credit data will begin impacting the mortgage market this year. But over the coming years it will likely be used by more lenders in other loan categories looking for better assessments of borrowers’ creditworthiness. Ultimately, trended credit data will likely impact not just whether borrowers are approved for credit, but also the interest rates they receive.
This modernization of the credit market, through innovative ways at analyzing credit data, could especially help low-income Americans, many of whom struggle to access credit today due to thin credit files. By revealing a more thorough picture of their payment history, approaches like using trended credit data would increase responsible borrowers’ chances of being approved for a loan to buy a home, start a business, or send their child to college.
Of course, there will always be naysayers who believe any expansion of the credit market jeopardizes the economy, by bringing into the system new borrowers who will eventually default on loans. But the use of trended credit data shouldn’t be used to extend credit to undeserving borrowers. Instead, it should help lenders find deserving borrowers whose traditional credit data might not show a full picture. In fact, the use of advanced analytics and trended credit data could actually reduce risk to the U.S. financial system by allowing creditors to assess risk more accurately.
Most Americans have little understanding of how the credit market works, which is why consumer advocates encourage everyone to obtain their free credit report once a year and examine it closely. By knowing what lenders see, consumers can modify their behavior and help improve their chances of accessing credit. The incorporation of trended credit data into those reports gives consumers more information about how to help improve those chances than ever before.
Today, credit is powering the world and our part in it is a role we do not take lightly. It is one that requires us to strive to look at innovative ways to leverage the data we are entrusted with for the benefit of the economy, consumers and businesses. As the marketplace evolves, so must we. Your grandfather’s credit bureau is a thing of the past and we are proud to be part of this latest innovation within the credit industry, certainly one of many more to come.
Trey Loughran is chief marketing officer, Equifax.