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Using an Alternative Scoring Model to Expand the Credit Box

house-sittingon-money1-300x198Fannie Mae and Freddie Mac consider only the FICO credit scoring model when making mortgage purchase decisions, but some believe that this singular method of scoring is locking potential buyers out of the housing market and cutting into lenders' businesses.

A bill introduced in December 2015 [1] is trying to change this singular model and move toward a more multifaceted model. The H.R. 4211 [2] bill, also titled the “Credit Score Competition Act of 2015 [2],” was introduced by U.S. Rep. Ed Royce [3](R-California) and U.S. Rep. Terri Sewell [4] (D-Alabama)—both members of the House Financial Services Committee—to the House of Representatives.

"The bill could positively impact millions of Americans who cannot currently secure mortgages or are forced to pick from less than stellar options simply because the system in place today doesn’t truly measure how financially responsible they are."

Trulia 

Both Reps. Royce and Sewell announced on their websites that the bill would allow Fannie Mae and Freddie Mac to consider alternative credit-scoring models instead of just the FICO model. This  would open up homebuying options for many consumers whose credit does not meet the current standards.

“The GSEs' use of a single credit score is an unfair practice that stifles competition and innovation in credit scoring. Breaking up the credit score monopoly at Fannie and Freddie will also assist them in managing their credit risk and decreases the potential for another taxpayer bailout," Rep. Royce said.

A recent report from Trulia showed that the use of alternate credit scoring models would help buyers obtain a mortgage [5] that normally would have missed out on. Fannie Mae and Freddie Mac own about 90 percent of the secondary mortgage market, so there is no room for competition in the credit-scoring industry, which Trulia says is hindering innovation.

"The model currently used to score borrowers is based on data from nearly 20 years ago and excludes millions of people that companies like Experian say are creditworthy but whose scores don’t reflect that under the system in place today," Trulia said. "The current credit-scoring model also effectively punishes borrowers who don’t have much of a credit history; a short or nonexistent credit history can drag down overall scores. With this system, if you’re financially responsible, a diligent saver, and debt-free, you could still miss out on a mortgage because you don’t utilize credit in your day-to-day life (some people do prefer to use cash)."

The FICO credit scoring system does not take into account that not everyone has access to traditional forms of credit that boost FICO scores, Trulia reported.

"The bill could positively impact millions of Americans who cannot currently secure mortgages or are forced to pick from less than stellar options simply because the system in place today doesn’t truly measure how financially responsible they are," Trulia concluded.

Click here [5]to view the full Trulia report.