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In a significant move for the financial industry, the Federal Housing Finance Agency (FHFA) announced last week that lenders can now use a second credit scoring methodology for government-sponsored Fannie Mae and Freddie Mac mortgages. This decision, implied to be consistent with President Trump's landslide mandate to lower costs, marks a new era in credit scoring.
The second credit scoring methodology in question is VantageScore 4.0, joining the long-standing FICO scores. The FHFA's announcement follows a multiyear transition period, during which lenders will be required to deliver loans with both scores when available.
The inclusion of these alternative scoring models is aimed at addressing the needs of the modern consumer. As FICO notes, "we use credit much more frequently than we used to," and if the models weren't updated, "seemingly normal credit usage today would be considered a higher risk than in years past."
One of the key updates in these new models is the consideration of Buy Now Pay Later (BNPL) lending. This type of small loan allows consumers to split payments on everyday purchases over a short time period. The process to expand and modernize credit scoring models has been in the works since 2014.
The inclusion of BNPL in credit scoring models can help reduce "phantom debt" and provide lenders with a clearer picture of an individual's financial situation. This is particularly important for consumers who may have never had a mortgage, auto loan, or credit card but are responsible with their financial obligations in other ways.
Another significant change is the inclusion of on-time rent payments in credit scores. A surge in third-party services now offers consumers the option to report their rent payments directly to credit bureaus. The inclusion of these payments can improve an individual's credit score, providing a more comprehensive view of their financial responsibility.
However, it is still relatively uncommon for landlords to report rent payments to credit agencies. Consumers are pushing for this to change, as it could help the 45 million people who have either no credit history or too small of one to produce a credit score, according to the Consumer Financial Protection Bureau.
Besides FICO and VantageScore, other companies offering credit scoring models include Experian with its Consumer Delphi Score Pro, which uses extended risk data and machine learning for enhanced credit risk assessment. Each new version of the credit scoring models has updated features to meet the needs of the moment.
FICO announced that two new versions of its scoring algorithm are expected to be available to lenders this fall: FICO 10 BNPL and FICO 10 T BNPL. These updates are part of the ongoing efforts to modernize credit scoring and better serve the needs of today's consumers.
While the use of the second credit scoring methodology is an option, not a requirement for lenders, it represents a significant step forward in the evolving world of credit. As more consumers adopt BNPL and other modern financial practices, it is likely that we will see continued updates and innovations in credit scoring models.
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