Cash-flow underwriting would bring fairness to mortgage lending

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In 1995, the mortgage buying and securitizing giants Fannie Mae and Freddie Mac began requiring the use of an obscure credit scoring model as part of lenders' evaluation of potential homebuyers. Thus began the institutionally ensured primacy of the FICO Score and its proprietor, the Fair Isaac Corp., a run that ended nearly exactly three decades after it began.

On July 8, Federal Housing Finance Agency Director Bill Pulte tweeted that Fannie and Freddie would begin accepting a second credit scoring model alongside FICO: VantageScore 4.0, the latest iteration of the joint venture between the Big Three credit bureaus Equifax, Experian and TransUnion.

Was this declaration a big deal or not? On the one hand, the FHFA had already announced three years prior that Fannie and Freddie would eventually phase in Vantage. That mandate was scheduled to go into effect in the fourth quarter of 2025, so from an implementation timeline perspective, Pulte's tweet only moved up the timeline by a few months.

Rollout date aside, surely the effect of adding a second scoring model will be transformative for potential home borrowers, right? A second model could mean a second chance at going from a "no" to a "yes," or a second chance at going down from a near-prime to a prime-plus interest rate.

That was certainly the view of Pulte, who continually came back to the fact that VantageScore 4.0 has the added feature of incorporating rental payments.

"My ORDER today (thanks to my boss, POTUS)," he tweeted a few hours after his initial announcement, "will allow for Americans to use their RENT to qualify for a mortgage. Credit history will no longer just include credit cards and loans. This is HUGE."

Unfortunately, for many mortgage applicants, the addition of Vantage will be less like two separate pulls from a deck and more like two pulls of the same card.

Fair Isaac and Vantage may be competitors, but their proprietary model scores are highly correlated because their underlying datasets are nearly identical. Case in point: The much-hyped addition of rental payments in VantageScore 4.0 is mostly redundant since the newest and soon-to-be-FHFA-approved version of FICO (FICO Score 10 T) also incorporates them.

Regardless of which scoring model you're looking at, the purported benefits of rent reporting are vastly overstated. The recent study that the New York Times gushed about and Vantage itself pointed to as evidence of rent reporting's positive scoring impacts only found material effects on moving consumers from unscored to subprime or near-prime tiers. In other words, rent reporting on its own may help you get a high-APR personal loan or credit card, but it probably won't help you get a home with affordable monthly payments. Even more damning is the fact that the most widely cited data point for the share of renters who are receiving the benefit of rental furnishing is just 5%.

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If Pulte is really serious about giving applicants as many bites at the mortgage apple as possible, he'll take a long look at a new data source that is much less correlated with FICO and inherently geared toward giving the fairest shake to the "millions of forgotten Americans" (his words) who don't heavily avail themselves of the mainstream credit markets.

Cash-flow underwriting — the process of evaluating credit applicants in real time based on the cash inflows and outflows from their bank accounts — offers the best shot at safely and meaningfully expanding homeownership opportunities. It's set up to find creditworthiness nuggets out of exactly the types of behaviors that Pulte was referencing that don't usually make their way to a traditional credit report, such as payments for rent, utilities and small-dollar loans. And unlike FICO and Vantage, which rely on the better angels of landlords' and electrical companies' nature to furnish payment information in a timely and accurate manner to the credit bureaus, cash-flow scorers have access to that raw payment information every month.

For those interested in learning more about the topic, there is plenty of publicly available information on the effectiveness of cash-flow scoring models in predicting credit performance. But Pulte won't have to take their word for it. He can mirror what his predecessors at the FHFA, Fannie and Freddie did to approve Vantage and FICO in years past and commission a "score-off" to determine which (if any) cash-flow scores warrant inclusion alongside the two legacy scoring models in the conforming mortgage marketplace.

What would this cash-flow score-off look like? We won't need much imagination. Pulte can more or less reuse the blueprint from the 2020 Credit Score Solicitation that eventually led to Vantage's approval, with just a few additional requirements pertaining to the underlying cash-flow data sources. All the evaluative parts can be left virtually unchanged. The methodologies and metrics that determine the efficacy of a credit bureau-based model apply just as well to a cash-flow-based model. Ditto for the legal framework, where all relevant requirements are technology-agnostic.

Make no mistake about it: If Pulte builds it, the cash-flow scoring applications will come.