in the mortgage industry unless political intervention derails it. In a letter to all its lenders last week, the Federal National Mortgage Association gave extensive details about how it plans to step up the use of credit scoring in its underwriting procedures in coming months. The plan puts Fannie Mae on the same road as the Federal Home Loan Mortgage Corp. in embracing credit scoring, encouraging its lenders to do so as well, and perhaps eventually requiring the use of scoring. Credit scoring involves using historical models to reduce creditworthiness to a single number. Most people in the industry agree it has potential to improve the underwriting process, but some have raised concerns that it may result in higher rejections of loans to minorities and low-income households. Disparate impact on minorities, even if unintentional, could cause problems for users of scoring, but there is yet no clear evidence that this may be the case. The Fannie Mae letter, signed by senior vice president Robert J. Engelstad, combines information with warnings and perhaps some jawboning. The text repeats a promise made to lenders last week by chairman James A. Johnson at the annual convention of the Mortgage Bankers Association of America in San Diego. "We won't go back and second-guess loans you have already made and ask you to buy them back if they don't match up to a new way of assessing risks and doing business," he told the conferees. But the letter makes it clear that the commitment is only temporary. It says Fannie Mae will not use credit scoring in post-sales reviews until lenders have had a chance to familiarize themselves with credit scoring and to implement their own scoring capabilities. "We recognize that the use of credit scores in mortgage underwriting is a relatively new approach and that it will take time for lenders to incorporate them in their underwriting procedures and decision-making process," the letter says. "During this transitional period, we will not use any credit scores we obtain as part of our post-purchase reviews as the sole basis for dialogue with individual lenders to assure that our guidelines on the use of credit scores are well understood and will be appropriately applied once the lender integrates credit scores into its underwriting process." The implication is clear: the use of credit scoring is inevitable, so lenders would be well-advised to adopt it on their own. And with Freddie Mac already using scores as an element of its quality control procedures, lenders don't have any genuine alternatives. They will soon be required to provide names and Social Security number with all loan files so Fannie can obtain credit scores. The letter also warns lenders not to make Fannie Mae a dumping ground for their riskiest loans. The letter says the risk profile of loan portfolios sold to Fannie Mae should be the same as on those sold to Freddie Mac. In supporting its stance, Fannie Mae says loans with particularly low credit scores account for about half of all defaults even though they represent a small fraction of all loans. Fannie is using a model from Fair, Isaac & Co., San Rafael, Calif., a pioneer in the development of credit scoring. Under the Fair Isaac model, scores of 780 or higher are premium-quality loans. It says defaults are heavily concentrated in loans that score below 620, the figure mentioned in the Fannie letter. While distribution of scores may vary from one portfolio to another, loans scoring below 620 are typically about 1% of a portfolio. The Fair Isaac scoring is derived from credit-bureau reports. Extensive guidelines for interpreting credit scores and using offsetting factors in the underwriting process were provided in the single-spaced eight-page letter. Supporters of credit scoring say it can be used effectively to speed approval of the easy loans, freeing time and resources to subject harder ones to more detailed review. But critics fear that the effect of scoring, regardless of intentions, may be to reject a high proportion of applications from minorities. So far, there is no hard evidence on this matter. Fair, Isaac points out that its models use only information available from credit bureaus and do not include factors such as loan-to-value ratios, income, marital status, or race. Sally Taylor-Shoff, senior project manager at Fair, Isaac, said major factors leading to low scores are poor payment records and excessive debt. Applicants with no credit-bureau history cannot be scored and must be evaluated separately, she said.

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