Outdated credit software proves costly to borrowers

Nation's Housing

February 24, 2002|By KENNETH HARNEY

EVER WONDER why you got charged a higher interest rate and fees on your mortgage than the best you saw advertised?

One possible reason is an issue now stoking controversy within the American mortgage industry: the use by lenders of outdated credit-scoring systems that tend to lower applicants' scores.

Outdated software frequently helps justify higher rate quotes and higher loan fees, critics say. If you need a 680 "FICO" score to qualify for a lender's best rate and yours comes in at 650, "the lender says, `Sorry, but you just missed the cut and I've got to charge you a higher rate,'" according to Richard F. Le Febvre, president of AAA American Credit Bureau Inc. of Flagstaff, Ariz., a national leader in efforts to improve credit scoring.

"FICO" refers to the predominant form of risk-evaluation score used in the home-mortgage market. The initials derive from Fair, Isaac & Co. Inc., the firm that developed the scoring technology. Scores are obtained by running the data in a consumer's credit file through Fair, Isaac's proprietary risk-prediction software. FICO scores generally range from the upper 300s to 850 and higher. The lower your score, the higher your projected risk of default on a loan.

Yet your FICO score for a mortgage application can vary significantly, depending upon the age of the software being used by the lender. Older FICO models, dating to the mid-1990s, penalize applicants for such things as having "finance company" loans on their credit histories, or for multiple "inquiries" from creditors requesting copies of their credit reports.

Such score-depressing factors have been modified or eliminated by Fair, Isaac in recent versions of its FICO models. But many lenders have not adopted these more consumer-friendly models and continue to use outdated versions that produce lower scores. Those lower scores, in turn, force some borrowers into higher interest rates, higher fees at closing and even higher down payments.

One of the country's largest home loan trade groups, the National Association of Mortgage Brokers, considers the outdated FICO model problem widespread and serious enough to issue a warning to its 13,000 members. Ginny Ferguson, the association's secretary and credit scoring committee chairwoman, said that "when lenders use [outdated FICO models] for pricing of loans, we can run into major problems."

Credit agency president Le Febvre takes the criticism one step further. He says some lenders have been slow to integrate the latest models into their underwriting systems because "there is a financial incentive to use the old models." Lower scores mean higher rates on loans for sale in the secondary market and may also generate higher fees for loan officers who bring in the applicants.

The problem is most acute, argues Le Febvre, for loan applicants who are "marginal" - decent credit risks whose scores nonetheless place them at the borderline of the "sub-prime" category. Interest rates charged to sub-prime or damaged-credit applicants can range from half a percentage point above prime to 4 percentage points or higher.

"I see it every day of the week," Le Febvre says. A mortgage broker orders a score on an applicant through a credit bureau such as Le Febvre's, using an updated FICO model. But then the lender to whom the broker intends to sell the loan runs the same applicant through an old model, "and guess what? The lender's score is lower. And that's the one that dictates what the borrower pays," says Le Febvre.

Fair, Isaac recognizes the problem but says it cannot require any creditor to use a specific version of its software. Even its most recent model - dubbed Next Generation - has not been adopted by most lenders and investors, well over a year after its formal release. There are substantial computer system costs to integrating new FICO models into lenders' underwriting programs, "and we are very sensitive to that," says Fair, Isaac spokesman Craig Watts.

What can consumers do about this problem? First, know what is in your credit file before you apply for a loan. And while you're obtaining your file, check out your FICO score direct from the source (www.myfico.com). More than outdated models, erroneous information in your credit file can depress your FICO score and push you into a higher-cost mortgage.

Second, ask your broker or lender for assurance that the model used to pull your FICO is no older than the late 1990s. Ask about multiple inquiries. If the software generating your score doesn't at least incorporate that advance - allowing you to shop among competing lenders for the best deal without penalty - consider taking your application somewhere else. Otherwise, your score is likely to be lower than the best you deserve.

Kenneth R. Harney is a syndicated columnist. Send letters in care of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071. Or e-mail him at kenharney@aol.com.

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