When Will Americans Know The Score?

When Will Americans Know The Score?

As payments are delayed and reporting restricted, credit scoring is looking at an unstable future.

BY JAMES POTTER CHARLET | CONTRIBUTING WRITER, NATIONAL MORTGAGE PROFESSIONAL

Everyone who’s appraising 2020 is looking at things like the presidential election, the Covid-19 outbreak, and the lack of sustainable outdoor seating at restaurants. We’re all focused on things like Zoom kindergarten classes and whether racial justice will ever come to our country.

So it’s no wonder that we’ve collectively missed seeing the big bomb that may be ticking away. Credit scoring, for many, many consumers, is really screwed up now.

This is critical, because whether people can afford to buy new clothing, upgrade their wheels or, more importantly, qualify for a home mortgage, all depends on their credit score. And almost every factor that’s used to predict the way we borrow, earn, spend, invest, and save money left 2020 looking far different than the way it arrived on January first.

THE REAL ON REAL ESTATE

We’re not even talking about basic economic upheavals, such as unemployment. We’re talking about the national credit rating agencies’ ability to predict the creditworthiness of borrowers, based on past indicators. If those underlying facts actually become facts that lie, the ability to adequately score a consumer’s credit becomes exponentially more difficult.

Let’s look, for example, at what’s happening with housing.

Housing has, rightfully, been at the forefront of many economic discussions during the pandemic with the focus on the immediate peril of those facing imminent evictions and foreclosures. As this was being written, President Biden was extending housing relief rules at least through June.

I don’t know how we will overcome this looming crisis, but I know there will be yet another predicament waiting for us when we are forced to address it. Currently, there are millions of mortgagors that have paused delinquency and foreclosure by moving payments they could not make to a future date through an agreement with their lender, a process called forbearance.

This increases the total amount of interest paid as well as the amount owed. It can also negatively impact several numbers that constitute credit scores, such as consumer debt ratios. Right now, to their credit, most mortgage loan servicers haven’t reported these COVIDimpacted loans as delinquent to credit reporting agencies. When will the reporting of past due payments resume? Will 2020 payments ever be recorded? Do forbearance accounts need additional documentation? What will Freddie and Fannie change for underwriting purposes? How will FICO calculations adjust to accommodate for these changes? These are only a small sample of the inevitable queries.

STUDENT STATS

Counterintuitively, both Experian and Fair Isaac released studies to the public in December 2020 reflecting a surprising decrease in delinquency rates, as well as increase in average credit score during the year. How did that happen? Because we’re turning a blind eye, that’s how.

We all witnessed unprecedented increases in unemployment and devastating reductions in consumer retail spending, so many forecasters had grim expectations for the average American credit report. In truth, doomsday may still be correct despite the recent, unexpected increases. According to the U.S. Dept. of Education, 54 percent of all higher education students in 2019 required financial assistance that averaged $37,000 of student debt per individual. Prior to March 2020, about 20 percent those student loans had some potentially detrimental payment history. Although that number has surely increased, there has been no record of it on credit reports as the repayment of most student debt has been suspended and will continue to be until at least September 2021.

Concurrently, the pursuit and escalated collection activity of already derogatory student debt has been suspended. As a consequence, no American has had a missed student loan payment recorded on their credit report now for twelve reported months. How we will reinstitute reporting of millions of past due payments and debt simultaneously at some vague time in a completely unknowable future is a disconcerting wild card in a surprisingly delicate credit system.

UNSTABLE ALGORITHM?

Finally, and perhaps most unpredictably, Fair Isaac Corp., the purveyor of the ubiquitous FICO scores, has fundamentally changed its core scoring algorithm nine times between 1970 and 2020. After living through the entirety of the last year with its burning koalas, Oklahoma tiger men, and murder hornets, many of you probably already guessed that the tenth iteration made its debut in the midst of our global disaster. By now, FICO and lenders would normally have months of real world data and feedback after millions of credit reports generated scores. Obviously, with the current data variations and omissions and, more importantly, with the uncertainty regarding how the data will exist post national emergency, the continued predictive efficacy of the newest FICO scores is shrouded in doubt.

A healthy American economy relies on average consumers to consistently spend what they earn – and then some – on goods and services in the domestic market. To do that (especially the “then some” part), requires credit. It’s the foundations of how to approve and provide appropriate levels of credit that elevates these hyper specific microeconomic predicaments into much larger potential problems. Mix credit worthiness with credit strategy, then blend with political policy, and it’s preordained that this isn’t going to be an easy problem to address.

That doesn’t mean we should wait to start figuring this out. There is a song titled “Everybody’s Free (To Wear Sunscreen)” that was popular in the late 1990s by Baz Luhrmann. In it, a graduation speech is juxtaposed against a techno/trance groove, but it is the content of the speech that I am thinking about now. The narrator gives lots of advice (“Be thankful for your knees. You’ll miss them when they’re gone”), but the only absolute, uncontestable advice he insists on is simple: Wear sunscreen.

Why? Because even then it was pretty clear that if you don’t follow the advice, you are going to pay for it later in life. Agree or not, the science is going to win. And that’s the scenario here, too. Agree or not, we’re going to get burned on measuring credit worthiness if we don’t start applying some science to it right now.

James Charlet is a former executive at Experian and owner of CRE Credit Repair. He is a frequent speaker in the mortgage industry, and serves as a consultant to multiple organizations. James is also a connoisseur of rap and hip hop from the 1985-2005 golden era; an appreciation he is desperately trying to pass on to his teenage son, Aidan.