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Have Lower Lending Standards Pushed Credit Scores Down?

It’s been one of the biggest stories to follow in mortgage lending: After years of too-loose and then too-tight credit access, average FICO scores are now slowly floating down, and the market looks a little more open for low-score borrowers.

But do these steady declines really indicate a loosening in standards among lenders? “Afraid not,” say researchers at the Urban Institute’s [1] (UI) Housing Finance Policy Center.

In a blog post [2] published late last week, UI’s Jun Zhu, Laurie Goodman, and Bing Bai assert, “A market composition change—not lower lending standards—explains the decrease in average credit scores for conventional and FHA [Federal Housing Administration] mortgages.

“Despite rising home prices and gradual housing recovery, the mortgage lending rules have remained tight, inhibiting housing demand and economic growth,” they continue.

In their post, the researchers examine Ellie Mae’s latest Origination Insight Report [3], which shows average credit scores for conventional purchase loans in March stood at 755, while FHA loans were at an average 684—both down from last year.

In their own findings, the UI team found credit scores for conventional mortgages averaged 752, down from 758 a year ago, while scores on FHA purchase loans were down to 686 from 697. The findings echo Ellie Mae’s latest Origination Insight Report, which showed average scores for conventional purchase loans at 755 and FHA loans at 684 in March.

However, pooling the loans together reveals credit scores were flat: “The average credit score of all purchase loans stayed around 730 during the one-year period—no actual credit easing.”

Rather, the researchers say the shifting market is behind the decreases in approved credit scores. With FHA raising its insurance premiums, private mortgage insurance has started to look more attractive to those borrowers whose FICO scores rate high by FHA standards but still fall on the low end of GSE standards.

As a result, the group says, FHA is losing business at the higher end of its credit score range, bringing its average score down. (According to the team, the share of borrowers in FHA’s 680–759 and 760+ brackets dropped as of March to 40 percent and 8 percent, respectively—down several percentage points in each bracket.)

Meanwhile, the GSEs are taking those same borrowers, in turn seeing their own average scores fall.

It’s because of that change—and not declining credit standards—that average scores are on the decline, the researchers conclude: “Most of the buzz about credit score declines in GSE and FHA loans are due to higher FICO score borrowers now choosing GSE lending over FHA—shifting the market share and reducing the credit scores of both.”