FICO Mutations And Subprime On The Way Back

The NYT has an OK piece this morning about walking away from your mortgage. It goes over well plowed ground, so if you’ve been reading up on this don’t bother with it. If not, it’s worth five minutes.

A couple ideas occurred to me as I skimmed it.

The author speculates that the hit to your FICO score for a foreclosure may be smaller in the future as the algorithm is amended to account for the unusual circumstances of the last couple years. Naturally, the spokesman for one of the company’s that creates FICO software discounts the probability of this happening any time soon. You don’t want to be out there telling your customers debtors that it’s no big thing to walk away.

I suspect that there may be some modification along these lines but I think the bigger story is likely to be the decline in the average FICO score that will be considered good. Keeping in mind that ratings of scores is based on how the scores of the population are distributed across a range, if a large segment of the population experiences a decline in their score, the relative measure of goodness should similarly shift.

I suspect that we are in just such an environment right now as millions of borrowers experience problems not just with mortgages but with all manner of debt they have incurred. The relative ease of walking away from a mortgage might well develop into an attitude that all debt can be similarly dealt with in which case, FICO scores in general should plummet.

The upshot of all of this in anyone’s guess. Lenders may well go back to more subjective analysis of credit although I suspect they are loathe to do so given the risk of litigation in such an approach. As mentioned earlier, the algorithms may be changed to account for the dislocations of the economy or Congress might intervene if they sense that FICO scores are shutting borrowers out of the credit markets.

The other item that sparked some interest was the author’s remark that some financial institutions are introducing credit products designed for those who have defaulted on debt.

Some lenders aren’t waiting that long to initiate their own foreclosure destigmatization programs. The Golden 1, one of the nation’s largest credit unions, now has a mortgage repair loan for people who have lost a home to foreclosure but want to buy a new one.

It’s hard to imagine that there won’t be a parade ofinsurance companies, credit card issuers and mortgage lenders in Golden 1’s wake, even though Fannie Mae and Freddie Mac may be unwilling to guarantee the mortgages of such borrowers for several years. In fact, Aaron Bresko, the vice president of lending for BECU, another large credit union based in Washington State, is putting together a panel called “How to Lend to the Newly Credit Impaired” for a conference later this year.

“Good people have bad things happen to them, so how do you find those people and reach out to them?” he said. “As the year progresses, it’s going to be an emerging market.”

Now all we have to do is find a name for this new type of loan. Is it too soon to resurrect subprime or do we need a catchy new phrase? Credit impaired or credit challenged sounds a little too condescending. We’ll have to do better.

Snarkiness aside, I am one of those who doesn’t happen to think that subprime mortgages or any other type of subprime loan is the root of all evil. When it was done right — big downpayments, intensive underwriting and proper pricing — the subprime mortgage market enabled a lot of people to have another go at home ownership. It got caught up in its own success and the lunacy of the rest of the market but that doesn’t negate the fact that originally it served a useful purpose.

So there are some thoughts for you on this Saturday morning. Some sort of significant change in the way we look at FICO scores and subprime coming back. I’m sure we will manage it better the second time around.

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