“Credit is a system whereby a person who can’t pay gets another person who can’t pay to guarantee that he can pay.” – Charles Dickens
In this current economy where foreclosures, unemployment, bankruptcies and consumer credit defaults are reaching epic levels, are credit scores irrelevant?
A credit score is a numerical expression based on a statistical analysis of a person’s credit files, to represent the creditworthiness of that person. A credit score is primarily based on credit report information, typically sourced from credit bureaus.
Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits. The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system.
Credit scoring is not limited to banks. Other organizations, such as mobile phone companies, insurance companies, employers, landlords, and government departments employ the same techniques. Credit scoring also has a lot of overlap with data mining, which uses many similar techniques. – Wikipedia
With on-time payments being the greatest influence on credit scores, and more and more people unable to make on-time payments, credit scores will drop dramatically.
What happens when these same people are able to improve their financial situation? If they had some major credit issues, such as a foreclosure, then it could take years for their scores to increase to acceptable lending standards. Does that really mean that they are not a credit worthy borrower?
For example, let’s look at a hypothetical scenario. Three years ago, a mortgage loan officer purchased a $500,000 home on a stated-income, option arm. His credit score at the time was over 700. No-brainer. Three years ago, this deal would have flown through, no questions asked. Today, he is unemployed, can’t make the re-set payment, is underwater, and loses the house to foreclosure. He gets a new job in a different industry. He makes less money than he used to (a LOT less) but it is stable and pays his rent on time for a year. He’s clearly back on track and in a much better financial position. He’s probably learned some valuable lessons too, not just about his own personal finances, but about mortgage lending in general. Unfortunately, his credit score may still be well below the lender’s minimum when he goes to apply for a mortgage loan to purchase a home that he actually can afford.
In this scenario, this borrower is actually a much better credit risk than he was when he purchased the $500,000 home, but under today’s lending guidelines, he would be turned down. In reality, it was the first loan, on the $500,000 home that should never have been approved.
Lenders are still relying heavily on credit scores and automated underwriting systems in which credit score is a major determining factor. If the AUS approves the loan, the lender approves it, in most cases. This is even if the underwriter has concerns about the loan. Conversely, even if the loan does make sense, without an AUS approval, it will be declined. Lenders are still overriding underwriter’s decisions in favor of the AUS decision.
Have we learned nothing from the downfall of our industry (and subseqently the entire economy)? Isn’t it time to get back to basics, stop relying on statistics, scores and automated decsions? Shouldn’t an actual person with years of lending experience look at all aspects of an actual borrower and make a prudent decision based on the borrower’s overall current financial situation?
- As originally published HERE.
Last 3 posts by phillenbrand
- Loan Modification Fix - July 20th, 2009
- Free Home Loan Modification Help For Homeowners - July 10th, 2009
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