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So far, 2022 has not been a great year for people looking to enter the property market. In addition to prices being high, mortgage rates have shot up and are expected to increase further. However, there is some good news for potential property owners. The Federal Housing Finance Agency (FHFA) is loosening its credit score regulations.
To be clear from the start, this is more an incremental improvement than a complete overhaul. A good credit score is still required to get a mortgage. The difference is in how your credit score is calculated.
The FHFA has started approving updated credit score models. What does this mean? Will it have much of an effect?
Here’s what you need to know.
Your credit score is essentially an assessment of your past credit behaviour to determine how likely you are to pay off new debts. It tells creditors how much risk you pose as a lender. Credit scores serve an important purpose, but they have fundamental flaws. Assessing risk is never going to be a straightforward calculation, especially when looking at human nature.
Over the years, people have gone from considering credit scores fairly accurate to understanding that they’re just what we have to work with. A credit score cannot tell creditors what is going on in your life.
You may have marks on your credit score from a period in which everything went wrong. Now, you have a great job and have started up a lucrative career ladder. What happened in the past doesn’t really say anything about how well you’ll pay debts off now.
To improve the efficacy of credit scores, credit agencies have been working on new models. This has led to the creation of the FICO 10T and VantageScore 4.0 models.
To get a mortgage, an applicant needs to provide credit reports from the credit unions. People who have bad credit struggle to get mortgages approved, with banks hesitant to take a risk with six figure loans. That is not changing.
What the FHFA is doing is finally approving the use of FICO 10T and VantageScore 4.0. Until now, only the Classic FICO model has been approved. This is in spite of the fact that improved models have been emerging for the past couple of decades – the last time credit score regulations were updated was twenty years ago.
Going forward, it will be easier for people to get a mortgage based on the fairer calculations made using the new models.
But is using updated models going to make all that much of a difference?
The updated models are not merely new calculations. They change the way that credit is considered by the agencies, as well as the information provided to potential lenders. Instead of looking at outdated information, lenders can see how the borrower has been doing over the past twenty-four months.
These credit scores don’t just look at loans, either. They include things like rent and utilities payments, which give a more holistic view of the individual’s financial wellness. There’s still no perfect way to predict the future, but this is a lot more equitable and opens the door to many people who have been held back based on their trouble paying off old loans.
“Compared to the prior version of the FICO Score used by the enterprises today, FICO Score 10 T can enable an increase in mortgage originations of up to 5% (without taking on additional credit risk) or reduce default risk and losses by up to 17%. These improvements in predictive power can help mortgage lenders safely avoid unexpected credit risk and better control default rates, while making more loans to more consumers.”
This change will provide relief to many potential homeowners who have seen their applications rejected thus far. This will also help the housing market, which is showing signs of strain, as demand drops in the face of high mortgage rates.
Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.