New Credit Score Rules Boon to Applicants

Home mortgage lenders across the country have just gotten new, important marching orders on how to use credit scores to evaluate loan applications fairly. The new rules could improve thousands of applicants’ prospects for obtaining a mortgage.

Rule No. 1: Never automatically disqualify anybody for a loan just because he or she has a subpar credit score.

Rule No. 2: Be aware of potentially erroneous information in electronic credit files as a cause of consumers’ low credit scores. Always use at least two of the three national credit data repositories--Equifax, TransUnion or Experian (formerly TRW)--as the information source for the credit score you order for each loan applicant. Never use just one source. If you turn up inaccurate information in a file, throw out the tainted credit score entirely.

Rule No. 3: When an applicant has a subpar credit score, look hard at the “score factor codes” that produced it. These include problems that may be fixable by the applicant, like overextended credit use, too many credit inquiries or lack of credit usage. Rather than simply shoving rejected applicants out the door, work with consumers to help them identify and correct the specific situation that produced the low credit score that disqualified them for a mortgage.

The new marching orders were sent out recently by the largest source of home mortgage money in the nation--Fannie Mae, a congressionally chartered private investor that buys billions of dollars of home loans from lenders every year.

The guidelines are significant because they address one of the fastest-growing--and troublesome--issues in the home mortgage arena: the use of credit scores that instantaneously brand applicants as good risks or bad.

The scores are used not only to grant or deny credit, but to price it as well. A low scoring mortgage applicant may get hit with a 1 or 2 percentage-point higher interest rate on a loan than a high scoring applicant. Low scorers also tend to be charged higher fees at settlement.

Credit scores have become an integral element in the shift to “automated underwriting” by lenders that allows a yes or no decision on a consumer’s loan application within minutes.

Yet critics say reliance on scores in a high-speed automated process can be extremely harmful when key information in an applicant’s credit file at a repository is inaccurate.

For example, the president of a Chicago-area credit bureau says he routinely sees mortgage applicants turned down--or charged more--for loans because their electronic file at a national credit repository contained bad data and couldn’t be corrected quickly enough.

Terry Clemans, president of Rolling Meadows, Ill.-based American Credit Connection Inc., cited a recent case where an otherwise qualified applicant file listed two unpaid debts totaling $800. The debts were paid off five years ago, Clemans said, but the collection agency that reported them to the credit repository never bothered to update the file.

With open, unpaid debts on record, the applicant’s credit score plummeted--and the borrower couldn’t qualify for a home loan at prevailing market rates.

Clemans said the new, consumer-friendly Fannie Mae guidelines “are right on target. What they’re saying is that the [credit scoring] concept is a good one, but lenders have to make sure the information behind the score is right” before declining an applicant.

The Fannie Mae advisory suggests that when consumers have low credit scores--and the file information is found to be accurate--loan officers should still consider approving the loan “based on other facts presented in the mortgage application.”

For example, the applicant may bring “compensating” strengths to the table that run counter to the low credit score. A low-scoring borrower may have a high-scoring co-borrower who reduces the effective risk to the lender. Or the applicant may have higher-than-average cash reserves. Or cultural factors may partly explain the low score.

Ethnic groups who avoid buying on credit, for instance, tend to produce lower credit scores because they have few or no credit cards, revolving charge accounts, etc. In such cases, Fannie Mae recommends loan officers evaluate the application using its “Nontraditional Mortgage Credit Report,” which looks to other payment histories--particularly rents--to assess borrower credit-worthiness.

The guidelines also urge lenders to look for “extenuating circumstances” over which the applicant had no control, such as an extended illness or a corporate layoff.

But not just anybody with a patch of bad luck deserves to get a loan under the new Fannie Mae guidelines. You have to have had “an excellent credit record before the extenuating circumstances occurred,” and you have to have demonstrated good credit practices for at least two years after it ceased.

Distributed by the Washington Post Writers Group.