It’s like getting a free scoop of ice cream 😊 According to Equifax about 11 million borrowers will have their credit scores increased by at least 20 points starting in July. Will you be impacted? What is the change? What information is now excluded? Is this all good news? Due to several lawsuits, the credit bureaus decided to make changes on what information is now included in credit reports.
What is changing? The three major credit bureaus are dropping certain items from the credit reports that have impacted a number of borrowers. According to Equifax, tax liens and judgments will likely be dropped since in order for them to show on your credit report after July they must contain four items (name, address, social, and date of birth). The vast majority of liens and judgments do not contain all this information so these “black marks” will be eliminated from the majority of borrowers.
Why is this important? Many borrowers could see their credit scores increased substantially without this information. This should theoretically help millions of borrowers get better terms on various financing products (mortgages, credit cards, car loans, etc…)
There is a big downside. The objective of a credit score is to measure the “riskiness” of a borrower and their ability to repay a mortgage. Lenders get very nervous when there are “dings” like judgments and tax liens on borrowers. Unfortunately, this information is no longer available to the lenders on the credit reports. What this means is that a lender might not be able to fully ascertain the “riskiness” of a borrower. For example, if someone has past income tax liens shouldn’t this be considered in a lenders decision to extend credit? Or how about a judgment that the borrower must pay back over time? Liens and judgements are indicators of credit worthiness that lenders will no longer see. Because of these changes lenders have no way to correctly assess the riskiness of a borrower.
Economics is frequently a zero-sum game with clear winners and losers. I suspect that lenders will react three ways (or a combination) to try and protect their lending quality:
- Lenders will increase their credit score requirements. If a substantial number of scores increased by 50 points, now the minimum score for a lender is 650 vs 600 before the change
- Many lenders might take higher loan loss reserves to compensate for the change. Higher reserves (or actual losses) decrease a bank’s profitability. They will “make up” this profitability loss by charging higher fees to other borrowers, account fees, etc… to ensure their revenue doesn’t decline
- If higher losses begin to occur banks will use alternative metrics. There are tons of data companies that can still track liens and judgments. Instead of just relying on a credit report, lenders likely will use alternative third parties to get this information and factor into their credit decisions anyway.
Although the news of a higher credit score sounds great on paper, the reality is that most lenders will adjust their lending practices to compensate for these changes. The actual benefits to consumers will be muted and many could actually be harmed as higher fees are passed on to more qualified borrowers to compensate for this change.
Resources/Further Reading:
- Fortune Magazine: http://fortune.com/2017/03/13/fico-credit-scores-personal-finance/
- Motley Fool: https://www.fool.com/credit-cards/2017/03/20/this-regulatory-change-means-a-credit-score-boost.aspx
- NBC News: http://www.nbcnews.com/business/consumer/changes-credit-report-criteria-could-boost-scores-n733596
Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).