Credit scores, and the end of mortgage forbearance

Experts discussed the future of credit scores and the specter of policy changes

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As part of the landmark CARES Act passed in 2020, Congress stipulated that mortgages in forbearance as a result of COVID-19 must be reported as “current” on credit reports. The legislation saved millions of homeowners from having their credit scores ruined during the most devastating year in recent U.S. history. But future risk still remains, and much remains undecided about the future of credit scores.

In a credit reporting panel moderated by U.S. Bank’s director of consumer bureau management Cory Patrick, Ethan Dornhelm, vice president of scores and predictive analysis at FICO, noted that 35% of the FICO score calculation is based on payment history. This category takes into account whether the borrower is paying their bills as agreed, if they are delinquent and have missed a number of bills, and how recently they missed them across their different accounts.

The three primary credit bureaus, ExperianTransunionEquifax, are reporting all mortgages in forbearance as current. In the section that lists how many times a mortgage had late payments, broken out by 30 days to 59 days, 60 days to 89 days, and “90+” days, the documents show all zeros.

That means: No late payments. The loan is, technically, current.

“In short, all of the common accommodation reporting options will not affect the FICO score calculation,” Dornhelm said. “So whether that’s reporting a special comment code pertaining to forbearance, or declaring natural disaster, or loan modification, none of those codes will directly affect the FICO score calculation, nor will reporting a borrower as deferred via the terms frequency value of D.”

The “AC” code

That D is a code used in credit reporting that goes in to the payment history profile when there is no payment history available (or reported for that particular month). According to Eric Ellman, senior vice president of public policy for the Consumer Data Industry Association, that code is not intended to remove accurately reported information in terms of what the consumer impact is, it’s simply a way to report zero payments.

Reporting a scheduled monthly payment amount of zero, or reporting any scheduled monthly payment amount at all, will not affect the borrower’s FICO score, because none of the variables in the widely used FICO models look at this scheduled monthly payment amount.

One code, however, that could potentially harm consumers is the one labeled AC. Back when the foreclosure crisis first began over a decade ago, many lenders were documenting modifications with the code AC, to indicate that borrowers were making partial payments. Since partial payments are symptomatic of future delinquencies, an AC notation in a credit file can drag down a credit score.

“I think the big question that emerged very early in the pandemic when there was very unprecedented levels of job loss and income disruption was just how much are the delinquency levels going to ramp up,” Dornhelm said. “On the contrary, what we’ve seen is delinquency reported to the bureaus has actually gone down, especially in mortgage, where the delinquency rate today is probably about half of what it was just prior to the onset of the pandemic.”

The AC code is still being used by servicers, but not as often as they did, panelists said at the Mortgage Bankers Association‘s annual spring conference.

Running the score

According to the MBA’s latest forbearance report, approximately 2.3 million borrowers are still in some form of forbearance, with a greater percentage exiting with loan modification and deferrals than before.

In a simulation run by FICO to analyze how these borrowers will perform upon exit, the organization isolated a population of consumers who were reported as having a mortgage in forbearance as of July 2020. The simulation assumed 80% of the total amount of the deferred monthly payment would aggregate into balance (i.e. interest and/or other escrow payments that would be additive to their outstanding principal). Running this variable against a six month and 12-month forbearance simulation, FICO tested the sensitivity of these borrowers FICO scores to increased mortgage balances being reported.

“We found the majority of the changes were actually quite modest,” Dornhelm said. “The majority of borrowers, 63% in the case of 12 months, experienced a score decrease of no more than nine points, the median being a six point decrease. If we tested this on even older versions of the FICO score, the impact would be even more modest because of how the amounts owed category was weighted.”

Policy changes ahead?

As the pandemic begins to near its end in the U.S. and servicers work to help homeowners exit with unaffected credit, Ellman said policymakers are pushing for changes that aren’t reflective of the bigger picture. (There have been rumors that the Biden administration may get rid of the three credit reporting bureaus altogether.)

“Clearly a lot of consumers that are hurting,” said Ellman. “But as we can see from several sources of data, in some cases, scores are at all time highs. If you’re using this idea of consistently wounded credit to drive policy discussions, then your policy driver is misplaced, because the data just doesn’t bear that out.”

Where Ellman sees the greatest rift in policy matters is the act of data suppression.

If an item is suppressed on a credit report, it means that the credit reporting agency is withholding the account information from anyone besides the actual person whose score it belongs to. But when information is suppressed, information doesn’t get updated, and a consumer may not reap the benefits of some payments he or she is making.

“The broader macro problems are several, including the fact that one of the lessons that we learned from the great recession is that taking away information from lenders, who no longer get a 360 degree view of a consumer, poses significant systemic risk,” Ellman said. “And when you’re suppressing data, you are essentially blinding lenders to risk or potentially inflating the value of a risk.”

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