The Federal Reserve Bank of New York recently did a study which found that, while mortgage loan originations increased through the second quarter of 2015, the increase is only for borrowers with credit scores above 660). See Liberty Street Economics, “Just Released: Releveraging the Consumer Credit Panel with Two New Charts,” August 20, 2015. Mortgage loan originations for borrowers with credit scores below 660, however, have remained below $150 billion a year since 2010, after peaking at $650 billion in 2006. Id. Faced with this lower number of originations, the Federal Housing Administration (FHA) has stepped in earlier this month to encourage lenders to consider borrowers with lower credit scores.
One of the reasons FHA-approved lenders may have shied away from borrowers with sub-660 scores is concern about having their performance statistics skewed by lower credit score borrowers’ potentially higher-than-average defaults. In order to encourage additional subprime lending in the face of that concern, the FHA has recently made an enhancement to the Neighborhood Watch System. (Neighborhood Watch is a web-based application that allows FHA employees, lenders, and the public to monitor the performance of FHA-insured mortgage loans among lending institutions by geographic area, loan characteristic, and other factors). Neighborhood Watch now has a “supplemental performance metric” that will allow users to better compare loan performance. The new metric will compare the performance of loans to borrowers with credit scores below 640 to other similarly situated borrowers. FHA hopes this ability to compare similarly situated borrowers will provide lenders with a more accurate assessment of the quality of the loans they originate to borrowers with lower credit scores by making clear what characteristics any defaulting loans share besides low credit scores.
Because lenders can now evaluate loan performance using different credit factors, they may be more able to identify lower score borrowers who are otherwise acceptable credit risks. In addition, the supplemental metric provides information regarding the FHA’s risk tolerance across different credit bands. Finally, the additional transparency should give some comfort to lenders that they will not be unfairly targeted for audit for making loans to borrowers with lower credit scores.
In speaking about the changes, Ed Golding, principal deputy assistant secretary for housing, said “[b]y better understanding FHA’s acceptable risk tolerance levels for a variety of credit scores, lenders will have the confidence to lend more broadly and FHA will have more data on how successful those lenders are.”
Based on data from Neighborhood Watch, FHA lenders with high early default rates may be targeted for audits and administrative actions, so it remains to be seen whether lenders view the change as potentially mitigating that risk.