Lenders Using Credit-Scoring Systems To Better Manage Collection

Credit scoring, which is rapidly changing the way home loans are made, could have an equally profound effect on the collections side of the business.

Banks, thrifts, and other mortgage lenders are starting to use the technology to predict whether delinquent customers are likely to pay-and to plan their collection efforts accordingly.

The lenders say they are getting late payers back on track more quickly and cutting costs substantially. In fact, they say, the strategy offers one of the biggest opportunities to improve profitability that the industry has seen in years.

The approach marks a "revolutionary" step toward focused customer service, said Richard DeLeo, managing director of loan administration at Countrywide Credit Industries, Pasadena, Calif.

"It allows us to better understand the problems of the customer before we get on the phone with them," he said.

Credit scoring, which first rose to prominence in the credit card field, uses a mathematical formula to produce a numerical score based on payment history, net worth, and other factors.

The home loan industry began using credit-scoring systems a few years ago to help evaluate loan applications. Applied to mortgages, it has proved to be a powerful tool in evaluating credit quality and reducing underwriting costs.

Only recently-in the last several months-has the information been combined with other payment data to create "behavioral" models that gauge existing borrowers' likelihood of default.

This use of scoring "is a money saver for the mortgage company and a good loss mitigation tool," said Robert Caruso, senior vice president and division manager for loan administration at Norwest Mortgage Inc.

"It allows us to spend more time with loans that really do need more attention," Mr. Caruso said.

Industry observers say the system advances mortgage lending to more of a science as opposed to the scattershot approach that lenders have previously taken to loan collection.

"The mortgage business is being much more sophisticated in using technology to drive costs down," said Rolland Johannsen, president of Furash & Co., a consulting firm in Washington.

"People are applying credit scoring much more intelligently," Mr. Johannsen said.

The scoring models are designed to flag faltering accounts as quickly as possible to stem delinquencies-one of the biggest profit cutters to servicing portfolios. Each time a loan becomes delinquent by 90 days or more costs servicers about $1,000 in administrative and property inspection fees, according to statistics from Freddie Mac, formally the Federal Home Loan Mortgage Corp. Each foreclosure costs $2,400 to $5,000 from losses of interest as well as legal and other related expenses.

The charges wipe out razor thin margins in mortgage lending. Companies typically lose several hundred dollars when originating loans and hope to recoup the money, plus a profit, through servicing. Lenders generally receive annual servicing fees of 25 basis points for a conventional loan and 44 basis points for a government loan. They also make money on the float they receive between collecting payments and remitting them to investors, and on escrow collections.

But not everyone is sold on credit scoring, saying it could point an accusatory finger at consumers on the lower end of the credit spectrum.

"The worst nightmare is to have some collection attorney calling you and telling you you're a deadbeat," said Edmund Mierzwinski, a director with the U.S. Public Interest Research Group, a consumer advocate in Washington.

At the same time, credit reports that are used in tabulating scores are often riddled with errors, Mr. Mierzwinski said. "Just because a credit score is in a computer doesn't mean it's accurate."

Lenders said they have a firm handle on how to apply credit scores. In general, borrowers that usually pay on time are offered more friendly reminders, while laggards with a long track record the are pressured to pay.

So far, a handful of lenders are using credit scoring on the payment side, mostly by creating their own systems. Use is expected to increase following last month's teaming of Freddie Mac and MGIC Investment Corp. on a commercial system that will be made widely available.

It is in the best interest of Fannie Mae, the Federal National Mortgage Association, and Freddie Macbest interest to help lenders avoid foreclosures. Each loan that a lender can restructure saves Freddie Mac $26,000, said Paul T. Peterson, senior vice president of the secondary marketing agency's servicer division.

Wells Fargo Bank, one of the pioneers of the process, is making 30% fewer calls to borrowers since testing the Freddie Mac-MGIC system, said William J. McClung, senior vice president and division manager for the San Francisco banking company.

Countrywide is also making fewer calls, saving the company personnel costs since fewer people will be needed on collections, Mr. DeLeo said.

Other lenders said their collection employees will be able to do their jobs better because they can avoid calling consumers that aren't in jeopardy of default.

"A collector is not happy making phone calls. A collector is happy collecting money," said Karin H. Pickard, senior vice president of the mortgage loan servicing group for First Union Mortgage Corp., Charlotte, N.C.

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