NATIONAL HARBOR, Md. – While consumers’ credit scores may be falling, and the amount of risk associated with even the higher scores has increased, the way those scores work continues to perform well.
That’s according to Sarah Davies of VantageScore, the credit score that is jointly owned by the three credit bureaus. "The credit score models are still performing effectively as far as comparative risk and rank ordering," she said during a session at NAFCU’s 42nd Annual Meeting.
But that’s small consolation for users of those scores like credit unions, who are seeing their members’ credit scores fall, and even the higher scores come with more risk than before.
"Three to four years ago, the amount of risk in the system was just a littkle over 1% of the portfolio," she explained. "Now it’s up to 6%. If you set your cut-off [for acceptable credit scores for real estate loans] at 750, back in June 2003 to June 2005, that meant your acceptable risk was at .4%. Now, if you haven’t changed your cut-off, you’re 2.4%. You may need to rethink your cut-off strategies."
Over all, Davies said, looking at all types of credit, the change isn’t as dramatic as when real estate is singled out, "but you do see that risk is creeping into the highest scores, and it’s creeping into non-real estate, as well."
As credit unions continue to offer loan modifications for their members, they need to understand how these actions impact their members’ scores, she suggested. The good news is that, for the most part, loan mods don’t have to have a drastic impact on a person’s credit score. It depends on the structure of the modification, and the impact can range from 50 points to the good down to 50 points to the bad.
For example, it’s better to rewrite the existing loan, rather than to close out the existing loan and write a new loan. In such cases, the loan modification can actually have a positive effect on the credit score.
Similarly, forbearance can range from no impact to minus 40 points, Davies noted, while short sales range from a reduction of 30 to 120 points depending on whether a charge off is involved in the process. Foreclosure will hurt a score by 120 to 150 points, and bankruptcy will lop off anywhere from 150 points to 350 points.
At that point, Davies counseled, a person has pretty well taken himself right out of the lending game, whereas the much smaller hits taken for forbearance or a well-structured loan modification. The problem, of course, is that for a lot of members, if they’re getting a loan mod, it’s likely they’re having trouble with other loans, as well, and the cumulative hits to the credit score could end up being more significant.
The same goes for the effect of downsizing credit lines. Decreasing a person’s credit limit has a minimal impact on the person’s credit score, but again, if it’s coupled with problems on other loans, the deterioration is going to accumulate.
One of the troubling trends Davies sees is the lack of validation of scores. VantageScore validates its model every year, which is sufficient for the model, but credit unions need to be validating their portfolio scores, as well. One California CU executive in attendance noted that the county in which his credit union is located has an unemployment rate of 12%. As a result, the CU rescores its portfolio every quarter. Davies agreed that in volatile times like this, rescoring needs to happen more frequently—possibly even monthly, in some of the harder-hit states.
While Davies said credit scoring models continue to perform well and remain valuable insight for underwriting purposes, she urged credit unions not to forget to use something just as valuable: their own, internal data. "Credit bureau data is great stuff. It’s very powerful when you have seven and a half million files to pull from," she said. "But you can look at your members’ individual spending habits and behaviors and overlay that on the score. There a lot of value in your own data brings to the table. When I worked at Chase credit cards, we absolutely used the additional data we had available."
