Examining FHFA’s Transition to a Bi-Merge Credit Analysis

As the Federal Housing Finance Agency (FHFA) has proposed to utilize two instead of three credit reports during the mortgage application process, TransUnion reports that the change could result in unintended consequences for consumers, while doing little to achieve the organization’s stated goal of reducing mortgage borrower costs.

TransUnion’s analysis found that moving to a bi-merge (using only two credit reports in the mortgage underwriting process) could result in two million consumers becoming ineligible for a government-sponsored enterprise (GSE) mortgage. Their ineligibility would be due to gaps that can exist among lenders when it comes to reporting. Using only two credit scores will often result in an incomplete and inaccurate picture being painted of a potential borrower–particularly if a consumer’s most favorable set of credit data is the one that gets excluded.

Additionally, 600,000 new mortgage borrowers per year could end up paying more in interest under the bi-merge than they would have if all the tri-merge information were used, and could cost consumers $6,600 in additional interest over the life of the mortgage.

Last October, the FHFA announced that the GSEs will work toward changing the requirement that lenders provide credit reports from all three nationwide consumer reporting agencies (CRAs). The GSEs have been working with stakeholders on a plan for implementing the change from a tri-merge credit report requirement to a bi-merge credit report requirement.

TransUnion, in its findings, reports that consumers most likely to be affected–those with credit scores hovering in the 620 range, the edge of GSE mortgage qualification–are disproportionately Black, Hispanic, low- to moderate-income (LMI) and first-time homebuyers. These groups of potential homeowners are 50% over-represented in that range. As a result, they may shoulder a number of negative consequences of moving to a bi-merge system.

“Under a bi-merge, first-time homebuyers who have thin files or are new-to-credit could become unscorable or, if they are scored at all, could be charged a higher interest rate than they would otherwise,” said Joe Mellman, SVP and Mortgage Business Leader at TransUnion. “Just one missing tradeline that may result from using one less credit report could dramatically impact eligibility and monthly payments. Ultimately, the decision to only use two credit reports could make all the difference in whether an interested homebuyer is able to buy a home or not.”

In addition to holding creditworthy borrowers out of the market, a bi-merge could have the reverse effect on otherwise ineligible borrowers, potentially increasing default risk. An estimated 200,000 consumers ineligible for an FHFA mortgage under the tri-merge system will borrow a GSE mortgage, and may find themselves in homes they cannot afford in an economic downturn. Incomplete information could also lead to some paying less interest than their true risk merits.

GSEs may also annually lose out on $4 billion in risk-based interest fees due to such loans. If that risk premium is to be made whole, those costs may potentially be passed on to taxpayers or subsidized through increased pricing for lower-risk borrowers.

“By intentionally bypassing vital consumer credit information from the third credit bureau, the proposed changes could result in miscalculated consumer affordability and risk,” said Jason Laky, EVP and Head of U.S. Financial Services for TransUnion. “As a result, many consumers will be given mortgages that they cannot afford or at higher cost. We’ve seen the devastating effect that had on homeowners during the Great Recession.”

The mortgage lenders that TransUnion surveyed relayed concern over compliance with fair lending laws, and the risk of potential gaming of the system for the two highest scores by lenders and consumers. They also questioned the value of moving to a bi-merge standard, given the significant expense the industry will incur to make the move.

While an important goal in making this potential change is to provide cost savings to consumers throughout the mortgage process, the analysis shows that this change may cost consumers more as a result. While there is a potential for consumers to see a $10 to $20 savings through the pulling of one less credit report, the aforementioned added implementation, legal and compliance, added risk costs and potential for higher interest rates would likely dwarf the savings–and could ultimately be passed back to consumers in fees outsizing any one-time data savings.

“Not only will consumers save less than one-fifth of one percent of mortgage origination costs by not paying for complete data, but mortgages could ultimately become more expensive if investors demand higher premiums to compensate for additional risks, vendors charge more to make up for a complex transition, and lenders charge more to recoup additional legal, compliance, and regulatory oversight needed,” added Mellman.

Click here to access TransUnion’s report, “Tri-Merge to Bi-Merge: A Look at the Repercussions to the Credit Ecosystem.”