A New Era of Mortgage Credit Scoring

Nonconforming mortgages are those that do not meet the underwriting standards of government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. While the size of the loan is the most common reason, there are a number of borrower-, property- and structure-specific factors that can push a mortgage into this bucket. Nonconforming loans are generally considered riskier for lenders and thus tend to carry higher interest rates than conforming loans.

Nonconforming mortgage originations (excluding jumbo loans) as a share of all mortgages has doubled over the past three years to reach levels not seen since the 2000s housing crash.¹ To help deepen the pool of US consumers eligible for more economical conforming mortgages in the face of pent-up housing demand, the Federal Housing Finance Agency in April expanded underwriting standards for the GSEs to include their first new credit score models in decades: VantageScore 4.0 and FICO Score 10T.

Incorporating additional consumer data like rent-payment history, these models are expected to provide a more complete view of a borrower’s creditworthiness. The GSEs began accepting VantageScore 4.0 through a limited rollout to approved lenders in late April, and FICO Score 10T is expected to be implemented in the coming months. Classic Fair Issac Corporation (FICO) scores will continue to be accepted as the GSEs transition.²

The share of alternative loans is a small portion of the overall market, but non-qualified mortgages—a cohort that includes a large portion of non-jumbo nonconforming mortgages—have historically been the largest segment of issuance within the non-agency residential mortgage-backed security space. Adoption of these new credit score systems appears to be happening faster than expected and may create refinancing incentives for borrowers, which we believe could weigh on conventional low FICO-specified asset pools. That said, the limited scope of the initial rollout may mitigate the near-term impact.³