Shocker: Even FICO Thinks Lending Standards are Too Tight

by Peter Thomas Ricci

May 14, 2014

It’s one thing for NAR to think that lending is too strict, but now even FICO has thrown its voice into the mix.

For some time, tight lending standards in the post-bubble housing market have been among the most consistent rallying cries for housing advocates (especially NAR and the NAHB), but now, a formidable voice has decided to chime in and join the chorus.

FICO – yes, the FICO, which produces the protocol credit scores for mortgage lending – recently ran some numbers through its system, and came to the conclusion that lenders could indeed lower their standards without suffering any losses.

How Tight is Too Tight?

The gist of FICO’s findings were:

Credit risk is a far cry from where it was during the bubble years; in fact, according to Joanne Gaskins, the senior director of scores and analytics for FICO, credit risk for mortgages is pretty much where it was before the housing bubble even started.
Because of how low credit risk is, Gaskins argued, banks can consider lowering their scoring requirements without suffering losses.
Numbers from FICO bear that out – in 2005, among consumers with a 700 FICO score, there were 36 responsible borrowers for every one who went into default; in 2011, though, that ratio jumped to 91 responsible borrowers for every defaulter. As Kenneth R. Harney put it for the L.A. Times, “That’s a huge decrease in risk to the lender.”

And FICO is not even the only credit score firm weighing in on lending standards. VantageScore Solutions, FICO’s chief competitor, found that the probability of default in 2012 was only slightly higher than in 2005, when that probability was at its lowest level.

What Would Lower Standards Mean?

We should point out that banks have, technically, lowered their lending standards, though as we’ve documented in the past, those declines have been incremental as best.

So what would a true, earnest lowering of requirements do for the housing market? According to a 2013 study by the Urban Institute and Moody’s Analytics, for every 10-point reduction in credit score requirements, the pool of potential borrowers rises by 2.5 percent. In other words, a 50-point cut in requirements would increase that pool of prospective homebuyers by 12.5 million.

Wells Fargo recently accounted that it would lower its minimum score on conventional loans from 660 to 620; will more major banks follow suit?