On Sep. 11, the Federal Housing Administration (FHA) announced that, starting Jan. 1, 2027, it would change its rules governing credit scores for FHA loans. The move could allow millions who are currently locked out of the mortgage market to get approved for loans, and reduce the credit score element of closing costs.
Let's be clear: this isn't a free-for-all for the uncreditworthy. What's changed is the addition of new credit scoring models. So, at the start of next year, an FHA lender can use VantageScore 4.0 scoring technology as well as two versions of FICO's offerings. Lenders making eligible loans backed by Fannie Mae and Freddie Mac can already use VantageScore 4.0.
Expect a Staggered Start
Although the official start date is Jan. 1, that doesn't mean the new scoring model will be universally utilized from that date, warned National Mortgage Professional (NMP) on Sep. 11. So far, only a couple of large lenders have committed to adopting VantageScore 4.0 quickly, and nobody is required to adopt it at all.
And even early adopting lenders will have to carry out extensive back-office work to prepare for implementation, which probably means relatively few companies will be offering the full suite of scoring technologies immediately. So, applicants might wish to check which scoring models a lender uses before making an application.
"FHA encourages mortgagees to reach out to their credit and technology partners to ensure that the necessary systems, processes, and capabilities will be in place to support implementation of the new credit score requirements," said the U.S. Department of Housing and Urban Development (HUD), of which the FHA is a part.
The FHA announced that it would be making these rule changes back in April. Its latest announcement sets the date for implementation.
What's So Good About the New Scoring Technologies?
At the moment, FHA lenders must use FICO Classic when establishing an applicant's score. From Jan. 1, they can use FICO 10T or VantageScore 4.0 if they prefer.
Both FICO 10T and VantageScore 4.0 use "trended data," which examines, over time, a consumer's credit behavior more widely. So, they're both arguably more accurate than the FICO Classic model.
However, VantageScore claims: "VantageScore 4.0 scores approximately 33 million more U.S. adults than FICO Classic or FICO 10T, including nearly 5 million additional mortgage-ready consumers. Among these are approximately 24 million dormant-file consumers, 77% of whom score Near Prime or Prime, revealing a significant population of experienced borrowers overlooked by legacy scoring models."
Clearly, this is VantageScore marking its own homework. But many in the mortgage industry do seem to think that the new option will allow many who are currently excluded from borrowing to buy a home to get approved for a mortgage.
Nevertheless, VantageScore 4.0 isn't a free pass for uncreditworthy people to get a mortgage. What it does is allow those with limited credit histories, no recent credit activity, or a record of non-traditional borrowing to be assessed by other criteria.
"By leveraging large data sets, VantageScore uses 400% more data to generate a credit score than legacy mortgage credit scores, providing lenders with a deeper view of consumer behavior," says VantageScore.
Getting approved isn't the only potential benefit for borrowers. The higher one's credit score, the lower one's mortgage rate tends to be.
Mat Ishbia, CEO of United Wholesale Mortgage, made an enthusiastic Facebook video when VantageScore 4.0 was adopted by Fannie Mae and Freddie Mac. The same benefits he describes will accrue to FHA applications from Jan. 1.
Some Rules for Lenders
Earlier this month, HUD published the FHA Alternative Credit Scores Preparedness Guide. This lays out some rules that lenders must follow when using FICO Classic, FICO 10T, and VantageScore 4.0.
It's worth a full read in order to catch nuances and details, but we have summarized parts of it:
- All borrowers on a loan must be scored using the same credit score model(s). So, a lender can't cherry-pick VantageScore 4.0 for one borrower and FICO 10T for the other(s), just because that's more likely to get the loan approved.
- Lenders must still carefully review borrowers' credit reports to ensure acceptable risk. The score is only one aspect of the credit review.
- All credit score models submitted to the FHA for automated risk assessment must be approved to be eligible for automated underwriting. If a lender submits two different models on the same loan, and one receive the "refer" status, the loan will likely need to go through manual underwriting
- FHA credit score thresholds will remain unchanged. Nothing below a 500 score can be approved. Scores between 500 and 579 can be approved with a 10% down payment. Scores of 580 and above can be approved with a 3.5% down payment. Other approval criteria still apply.
- The Minimum Decision Credit Score (MDCS) is determined as follows: With one credit score, that is the MDCS. With two credit scores, the lower one applies. With three credit scores, the middle one is used.
Industry Enthusiasm for the Rule Changes
"The majority of mortgage industry trade groups and professionals reacted in a supportive but pragmatic way following an announcement from federal housing agencies that detailed moves to modernize mortgage underwriting by introducing newer credit scoring models," reported HousingWire back in April when the FHA's plans were first unveiled. "They largely welcomed the shift while emphasizing that the real test will be in execution and follow-through."
"In a letter sent to FHFA in July last year, the American Bankers Association [ABA] and three associations said the use of VantageScore and FICO could help achieve the shared goal 'of a more efficient, more transparent and more competitive credit scoring system that serves as many creditworthy Americans as possible,'" according to the ABA's website. The FHFA is the Federal Housing Finance Agency.
Much of the industry's enthusiasm is likely because the move breaks FICO's longstanding dominance in mortgage lending, which many hope will increase competition and reduce the costs of credit scores.
That's separate from another change the mortgage industry has been pushing for: moving away from the current "tri-merge" credit-reporting model, which requires information from each of the three big credit bureaus, Equifax, Experian, and TransUnion. FHA's new credit-scoring rules allow lenders to utilize the VantageScore 4.0 and FICO 10T scoring models, but still requires them to obtain scores from all three bureaus.
"The tri-merge credit reporting requirement has become a license for price gouging and ripping off consumers," wrote the Mortgage Bankers Association's (MBA's) president and CEO on the association's website early this year. "MBA and its members have had enough. Shielded by a government-granted oligopoly, the credit bureaus have used a no-choice system to raise prices and resist competition at the expense of mortgage borrowers and lenders."
It will take awhile before we're able to fully assess how this new change will impact borrowers, but the mortgage industry largely supports the FHA's decision. Here's to hoping that the move truly does allow more prospective homebuyers to enter the housing market.
