Oct. 2015 - Diversified We Stand, Divided We Fall

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TH E M R EP O RT | 25 FEATURE T he past seven years have hit the mortgage industry hard on both the borrower and lender side. However, minority borrowers seemed to have suffered disproportionately, even as the economy and the housing market show signs of recovery. When the bottom fell out of the housing market, subprime lending was identified as the root cause, so lenders pulled back on their credit standards. When the Qualified Mortgage (QM) rule was introduced in January 2014, the market contracted yet again on credit for fear of making a loan that would be ineligible for sale. However, research has since indicated that tightening credit standards don't actually make safer loans. An analysis by the Urban Institute has determined that the mortgage industry missed out on nearly 4 million loans from 2009 to 2013 due to tight credit standards, and the primary demographic that has been excluded as a result are low- to moderate-credit borrowers (i.e. borrowers with FICO scores below 660 and between 660 and 720, respectively). Unfortunately, that demographic also includes a significant number of minority borrowers. When it Comes to Credit Scoring, One Size Doesn't Fit All T he biggest culprit in regards to why minorities were excluded seems to be the defi- ciencies in current credit scoring models. As the saying goes, "It takes money to make money," and the same holds true for credit. Until you have a history of it, most lenders aren't going to take the chance on giving it to you. Using alternative credit data has long been viewed as a way to provide additional access to credit to consumers with "thin" or non-traditional credit histories, and a recent report by credit reporting agency Experian seems to validate that assessment. According to Experian's research, adding positive payment information, such as on-time rent and/or utility payments, can have a dramatic positive effect on a person's credit profile. Using a simulation based on the VantageScore 3.0 credit scoring system, Experian determined that nearly 77 percent of consumers in the study experienced a score increase when the positive payment information was taken into account. For subprime and nonprime consumers, the effect was even more dramatic, with 95 percent and 75 percent of consumers receiving a score bounce from the inclusion of alternative payment data. MidAmerica has seen this work very well with Native American lending products (see sidebar: Hope for a Home), so there is real-world evidence that this can be done. However, the use of non-traditional credit data is built into the requirements of Section 184 loans. For this to be put into action on the conforming/conven - tional side, you would need for 1) the credit scoring agencies to work this data into their algo- rithms in order to create a more complete picture of the credit risk a potential borrower poses and 2) investors to sign off on using this data for underwriting decisions. Shifting Perspective to Open New Lending Avenues R egardless, something clearly has to change. So what can the industry do in the meantime to remedy this situation? First off, lenders need to exam - ine their product mix, as well as their policies and procedures, to ensure they aren't unintentionally excluding minority borrowers. In this post-QM environment, lenders are becoming more comfortable working with the underwriting requirements this rule enacted. Furthermore, inves - tors are taking advantage of the opportunity to fill the non-QM void with higher-DTI products that while still perfectly sound, credit-wise, don't adhere to the strict QM requirements. Taking the time to explore your product options beyond QM or reassess the underwriting standards you've put into place for existing products can go a long way towards addressing a too-restrictive product line-up. For example, offering mortgage Correcting the Overcorrection In an attempt to tighten standards after the subprime meltdown, lenders unintentionally shut minorities out of the market. Now, alternative credit scoring is helping to bring them back to the closing table. By Jeff Bode

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