Recent analysis by the CFPB has spurred changes to FICO, but how will those changes impact your real estate business, if at all?
FICO, aka the most prevalent credit-rating system in the U.S. and a key component in the home financing process, announced changes to its system this week.
Spurred on by research from the Consumer Financial Protection Bureau, which found that both paid and unpaid medical debts could unfairly penalize a consumer’s FICO score, the credit rating agency will revise the formulas that compute its credit scores to avoid such penalties.
FICO factors into 90 percent of lender decisions on loan amount and interest rates, but how will its recent revision affect the mortgage markets? Here are three things you should know:
1. The Changes are NOT Immediate – Though the FICO changes have been officially announced, don’t expect them to instantaneously increase the credit scores for millions of consumers. Lenders have to overhaul their systems, first, to factor in the new FICO formulas, and experts predict it could take a year or more for the changes to be fully implemented.
2. It May Not Even Help Housing – True, millions of Americans may see their credit scores improve with the FICO changes, but Greg McBride, the chief analyst at Bankrate.com, explained to the L.A. Times that the effects will be more muted for the housing market. “These are not changes that are going to turn on a fire hose of new loan applications any time soon,” McBride said. “For a lot of people, it’s not so much going to be the difference between being approved and denied as it is the terms on which you are approved.” It’s more likely, the Times noted, that the FICO changes will be noticeable for auto loans and credit cards.
3. The Credit Bump May Not Be Much – But what about those loan terms? The actual bump to someone’s post-revision FICO score may not be all that much. According to Fair Isaac Corp., the company that provides FICO scores to the nation’s largest credit-rating firms, the changes could increase someone’s credit score by 25 points – and that’s only if an unpaid medical bill is the consumer’s only major delinquency.
4. Long-Game Gains – In the end, though, we shouldn’t be glib, because even a 25-point increase can lower one’s interest rate and ensuing monthly payment. Per a Informa Research Services analysis cited by the Times, a FICO score of 675 would lead to a 4.75 percent interest rate on a 30-year FRM for a $400,000 loan, with $2,086 a month in principle; if the FICO score is 700, though, the rate drops to 4.212 percent, and the principle drops $127 to $1,959.
In case your math is fuzzy, $127 multiplied by 12 is $1,524, and $1,524 multiplied by 30 is $45,720. So over the life of the loan, even a seemingly minuscule change to FICO could prove quite influential.