The push to standardize subprime credit ratings is being led by Standard & Poor's Corp.
The rating agency has developed seven risk grades, RG1 through RG7, to replace the A-D rankings mortgage lenders now use to rate a loan's credit quality.
The S&P rankings are based on expected foreclosure frequency.
Standard & Poor's, working with the Federal Home Loan Mortgage Corp., or Freddie Mac, devised the rankings using automated underwriting and mortgage scoring.
Previously, only loans of high credit quality accepted by Fannie Mae and Freddie Mac had standardized criteria. The grading of subprime loans varied from lender to lender, making their performance difficult to predict and the loans difficult to securitize.
The rules-based system previously used by lenders to rate borrowers' creditworthiness was inadequate, Standard & Poor's found. Instead, lenders should use "risk-layered" scoring, which combines the effect of several factors in measuring default probability.
Lenders who specialize in subprime mortgage loans have been divided on the issue of credit scoring. Many feel too many factors are involved to rate a borrower mechanically.
Although an automated underwriting system increases the consistency of loan performance evaluations, quality control remains very important, Standard & Poor's said. Lenders must ensure that information on the mortgage application is accurate and that calculations are consistent.
Investors in mortgage-backed securities now have a whole new profit vehicle: Fannie Mae announced last week that it is offering the first securitized pool of Title I home improvement loans.
Any Fannie Mae lender can now deliver current or seasoned Title I loans from the Department of Housing and Urban Development's FHA program to be securitized in multiple- or single-lender pools.
Fannie Mae, the Federal National Mortgage Association, announced in January 1995 that it would buy Title I loans to be securitized. Since then, the agency has amassed more than $250 million of these loans.
Title I loans, intended for low- to middle-income borrowers, are made to otherwise creditworthy homeowners who have little equity in their homes.
Fannie Mae said it expects the move to increase the Title I market significantly. More lenders will be comfortable offering the product, the agency said, because they no longer need hold it in their portfolios. In addition, Fannie Mae's faster funding and streamlined processing will attract lenders, the agency said.
Loans of up to $25,000 are available for one- to four-family dwellings. The credit history of the borrower, not equity in the home, is the determining factor in granting a Title I loan.
Ginnie Mae, the Government National Mortgage Association, is also offering to buy Title I loans for securitization, but the agency has not announced a deal since creation of the program three months ago.
The Title I loan market is expected to grow to more than $2 billion by 1998, said Fannie Mae.