Fed Gives a Boost to Credit Scoring in Home Loans

The Federal Reserve is throwing its considerable clout behind mortgage credit scoring, becoming one of the first banking agencies to weigh in on the growing industry practice.

Mortgage credit scores "are a predictor of loan performance," Fed analysts wrote in the July issue of the agency's bulletin.

The assessment is bound to buttress the case that government housing agencies and mortgage insurance companies have been making for mortgage scoring, industry observers said.

"If you are looking for a third-party endorsement, you can come up with none better," said Jonathan Gray, a mortgage banking analyst at Sanford Bernstein & Co., New York. "This will encourage increased use and reliance on credit scoring," Mr. Gray said.

Credit scoring - a process in which a prospective borrower is given a numerical score based on such factors as income, net worth, and credit history - could be an important tool for lenders trying to counter narrowing margins, the Fed analysts wrote.

Indeed, many lenders are finding they must evaluate and manage the risks of lending to nontraditional borrowers and of allowing greater flexibility in loan underwriting. Incorporating credit scoring into the process can provide important insights, the researchers said.

Critics say credit scoring is too impersonal, and mortgage brokers fear inaccurate data. Both factors could lead to rejection of borrowers with borderline credit.

The Federal Reserve, while avoiding the debate over the method's fairness, does find that there is a high correlation between low credit scores and problem loans. "The proportion of problem loans increases as credit scores decrease," the analysts said.

For instance, when considering a basket of new government-backed loans, the researchers found that 1 of 10 low-scoring loans were delinquent but just 1 in 100 loans with high scores was past due.

The analysts, in the Fed's research and statistics division, culled from data supplied by Equifax Credit Information Services, a storehouse of credit information.

The analysts found that a group of mortgages with low scores and high loan-to-value ratios were 50 times more likely to be foreclosed upon than loans with high credit scores and low ratios.

"Credit score and, to a lesser extent, loan-to-value ratio, appear to be much stronger predictors of foreclosure rates than income," the Fed analysts said.

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