ARE FICO SCORES OUTDATED IN RATING RISK OF HOME LOAN APPLICANTS?

Analytics firm Digital Risk says relying mainly on FICO scores has failed to predict many defaults and may misjudge many of today’s mortgage candidates.
In a recent L.A. Times article, Kenneth R. Harney reports on a new lender analytics tool with an intriguing premise.
“Digital Risk, a mortgage analytics firm, is mounting an unusual frontal assault on one of the lending industry’s sacred cows. It argues that credit scores such as FICO failed to predict large numbers of defaults during the mortgage bust years — most notably thousands of “strategic” walkaways by borrowers with high scores — because they could not anticipate homeowners’ reactions to economic stress…
‘The mortgage industry is relying on outdated methods to determine risk,’ says Peter Kassabov, chairman and chief executive of Digital Risk, which is based in Maitland, Fla. ‘During the mortgage crisis, high-FICO borrowers encountering distress defaulted in huge numbers, yet we still depend heavily on that one score along with [down payments] to make lending and loan modification decisions.’
According to one study conducted in 2009, 588,000 homeowners walked away from their homes strategically during 2008 alone. This amounted to 18% of all serious defaults that year and shocked the mortgage industry. Fair Isaac, creator of the FICO score, acknowledged the problem, and last year released an analytic tool that lenders can use to detect potential strategic defaulters — high-scoring, credit-savvy borrowers primarily — before they stop paying.
Digital Risk, however, says strategic default is not the only weakness of traditional credit scores. The company describes itself as the “nation’s largest provider of mortgage risk, compliance and transaction management solutions,” and claims to have seven of the top 10 mortgage lenders as active clients. In early August it introduced a multidimensional risk evaluation system it calls “Veritas,” which it says integrates borrower credit characteristics with property and local real estate market data along with proprietary behavioral prediction models. The behavioral component includes what the firm calls statistical “clusters” of borrower, property and market situations — 123 in all — that give lenders a better idea of how an applicant will react to financial problems, such as the next recession or housing downturn.
The system is based on analyses of more than 5 million loans originated from 2006 to 2011, plus a separate study of how 100,000 borrowers performed after having their loan terms modified, according to the company. Alex Santos, president and co-founder of Digital Risk…
The value of this for mortgage applicants whose scores don’t meet today’s high requirements is significant…
Fair Isaac isn’t taking critiques of its scoring lightly. Anthony Sprauve, a FICO spokesman, said: “We continually work with our customers to make sure the FICO score is the best predictor of a person’s likelihood to repay a debt. Our customers vote with their feet since, according to [research firm] Tower Group, lenders ask for FICO scores more than 90% of the time when buying scores from the big credit bureaus.”
Veritas is already being used by a small number of lenders, Santos said, but as a newcomer to the mortgage risk-scoring marketplace it will take time to be validated and widely accepted — if ever. But the issue it raises is intriguing: Are there better technologies to evaluate loan applicants than scores based on credit histories?
The jury is out. But in the meantime, if you plan to buy or refinance, keep your FICO score as high as possible because FICO is still what your lender is going to check.”

Link to original article here.

Posted on August 19, 2012 at 5:24 pm
Nancy Low | Category: Buyers, News, Sellers

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