A new type of credit score could allow many more people, especially minorities, to qualify for a home mortgage.
The Federal Housing Finance Agency (FHFA) recently announced that the FICO 10T and VantageScore 4.0 would replace the traditional FICO scores when borrowers want to qualify for home loans.
If more mortgage companies use VantageScore 4.0, this can benefit underserved communities because, unlike the traditional FICO model, VantageScore 4.0 includes rent, utility, and telecom payments.
Markia Brown, a Certified Financial Education Instructor, echoed this sentiment saying, "With the FHFA announcing the transition…this will open the door of homeownership for a lot more people, especially in communities of color and other underbanked communities."
However, the transition to these new scoring models will take a "multi-year implementation phase,'' says FHFA Director Sandra Thompson.
Michael Metz, operations manager for V.I.P. Mortgage, Inc., explains: "Since this will be a larger impact on how not only the scoring is done, but also how it’s reported, it’s likely to be open to industry dialogue next year and started to implement in 2024."
Here are some key differences between the traditional FICO score, the FICO 10T score, and the VantageScore 4.0.
Traditional FICO vs. FICO 10T and VantageScore 4.0
Traditional FICO Score
This is the traditional credit score most lenders use to make credit decisions. The score breaks down as follows.
- Payment history (35%)
- Credit utilization (30%)
- Credit age (15%)
- New credit (10%)
- Credit mix (10%)
Payment history, the largest portion of the score, shows whether or not you made payments on time. It offers data from the past seven to ten years and does not include trended data.
FICO 10T Score
This is the newest version of the FICO score. Here are its main features:
- It includes trended data, focusing on the past 24 months plus. FICO explains: "The credit scoring model determine[s] what your "trend" is: are your balances trending up, down, or staying the same?"
- It gives lenders more insight into how consumers handle finances, including whether or not they tend to carry a balance.
- It emphasizes recent activity, so recent delinquent payments may hurt credit scores more using this model, according to Investopedia.
VantageScore 4.0
The three main credit bureaus created the VantageScore, a competitor to the traditional FICO score. Similar to the FICO score, it scores consumers between 300 and 800. The difference, according to VantageScore, is that it uses machine learning and trended data.
The new VantageScore 4.0 enabled scoring of "approximately 37 million more consumers who typically are not scored by conventional models without relaxing standards." This includes 3.8 million minorities, according to the VantageScore 4.0 fact sheet. Thus, it is a much more inclusive credit scoring model.
Who will benefit most from the new credit scores?
The new credit scoring models will especially benefit people in these situations:
- People with limited credit histories. Factoring in rent and utility payments "would improve credit scores, especially for consumers who have limited information in their credit files," according to VantageScore.
- Minorities. "Limited credit information is a common trait for underserved consumers including some African Americans, Latinos and recent immigrants, even though they consistently pay rent, gas, and electric bills on time," VantageScore says.
- People who have turned around their finances. The FICO 10T, focuses on trended data over the last 24-plus months, which benefits people who have cleaned up their finances after a rocky past.
Other barriers to home ownership for minorities
Many economic factors can hurt a person's ability to qualify for home loans, but using different credit scoring models when determining mortgage eligibility is a step in the right direction. Here are three key factors that hold people back from qualifying for a mortgage.
Not having a bank account
Having a bank account is a crucial step to qualifying for a mortgage. But, according to a report by the Federal Reserve, 13% of Black adults and 9% of Hispanic adults don't have a bank account, compared to 3% of white adults.
Distrust of the banking system
One reason many Black Americans remain unbanked is a distrust of the banking system.
Marcus Anthony Hunter, a writer for The Chicago Reporter, explains, "Black wealth issues [are] historically rooted in a persistent pattern of loss and mistreatment beginning with the mishandling of freedmen’s and freedwomen’s money during Reconstruction."
Lack of a credit score
A final part of qualifying for a mortgage is having a credit score, preferably an excellent one, to qualify for the best interest rates.
Yet, according to a HousingWire report, "almost 30% of Black adults did not have a FICO score in 2018, compared to just 17% of white adults, with Black consumers also comprising 34% of FICO scores below 620 (16% for white borrowers.)"
Key takeaways
- One of the biggest barriers to owning a home is qualifying for a mortgage.
- Homeownership is one of the best paths to financial stability and independence.
- The step toward more inclusive credit scoring may help to break down those barriers and put more Americans on the path to homeownership.