The recent turmoil in the financial markets has resulted in some hard lessons for everybody. One of the groups hit hard by mortgage defaults has been mortgage lenders. Faced with defaults on the one hand, and forced mortgage modifications on the other, mortgage lenders are in a precarious position. Any creditor needs to base its decision to lend, and the interest rate to charge, on the likelihood that the borrower will default on the loan. Credit scores are supposed to help predict that, but their prediction powers are only as good as how well they model consumer behavior.
Recent events demonstrated that there were ways the credit scores could predict default better. First, the scores were not good at differentiating between a person who occasionally or infrequently is late on a payment and somebody who is chronically delinquent on debts owed. So the formula has been restructured to reflect that. In addition, the old models used to give a bit more benefit to people who built credit by being an authorized user on the account of somebody who had better credit. Often that would be children on their parents’ accounts and spouses on the account of a spouse who had a better score. The models now make it harder to use somebody else’s record to boost your creditworthiness.
The end result of these adjustments is that some people will now have a harder time getting mortgage loans. For people at the top of the credit score scales, there is no real difference. And for people in the middle who occasionally struggle with a late payment, it might become easier. But for people at the lower end of the model, being approved for large loans will get harder.
The is because as banks look to tighten lending standards, they will block out the lowest scoring borrowers first, or will charge higher interest rates to compensate for the increased risk of default. By breaking out the infrequent late payers from the people who have chronic failures to pay, the perpetual problem debtors find will be harder to get loans. In addition, the change to piggybacking on other consumers’ credit will also hurt people who are trying to establish credit histories. Many people, including younger borrowers and recently divorced adults who never maintained credit in their own name, will find that their scores will stay lower for longer.
Easy access to mortgage loans is a thing of the past, other than for borrowers who can show a good likelihood of repayment. The adjustment to the credit score models might make it harder to access large loans, but those changes were done at the request of the lenders to help them decide which customers are a good risk and which are a danger of default. When lenders make those choices with better information, everybody comes out ahead. The lenders face fewer defaults, good borrowers have access to credit, and risky borrowers are not permitted to get themselves into loans that are over their head.