Common sense and use of credit scores don’t go together
Glenwood Springs, Colorado CO
Consumer credit scores drive the granting of credit today. As virtually everybody knows, these are numerical distillations of a consumer’s credit profile, taking into consideration a variety of factors, including total indebtedness, monthly debt service, and manner of payment. Values are assigned to the various elements, with the higher ones being the best. Added together, they become a composite credit score. Above a certain number, you qualify for credit. Below that criterion, you don’t.
Back in the last century scores weren’t attached to credit reports. Lenders actually had to read the document. Although, naturally, they would attempt objectivity, the ultimate decision was, by definition, subjective. This common sense, onesy-twosy approach worked well for a long time.
But, as the world’s economies exploded, with more homes, office buildings and apartments, more cars coming off the assembly lines of Asia, Europe and North America, with many more people being able to afford the production, the lending process was compelled to streamline itself.
As the world capital markets generated a feeding frenzy in high yield investments, billions of dollars of securitized debt was created. This paper, to be marketable to the sovereign funds and others with trillions of euros, yen, and rubles to invest, had to have relatively simple specs to price the securities from “A” right on through the alphabet.
Credit scoring is a pretty slick tool, and like all of its ilk, it didn’t take long to figure out how to misuse it. Although the concept is certainly sound, it was used to speciously leverage massive amounts of questionable debt. Simply stated, the packagers of these reams of mortgage-backed securities managed to convince investors that the guy who was able to make the payments on his F-150 pickup could handle an extra quarter million on his home mortgage.
Mortgages of 100 percent of an inflated value, with no verification of the borrower’s income or assets, were made as long as that sacred credit score was above a certain number, it was fun, fun, fun until Fannie takes the house away.
Now, loan underwriting has returned to sanity but common sense is still taking a back seat. Credit scoring is again being misused, in a different way.
Here’s the view of the suppliers of capital today, Fannie Mae, Freddie Mac, and the money center banks: Loans with credit scores above a certain number are good, those below, bad. We tell the regulators that we don’t make bad loans anymore, so we just want the higher scores. The regulators like this, because it makes their job easier; low score, classify the deal down, higher score, higher rating.
This knee jerk reaction is curtailing credit, contrary to the Federal Reserve’s goal of making credit more available to provide the stimulation necessary to emerge from the recession. And, the Fed has criticized the policy, which has mostly fallen on deaf ears.
Common sense dictates that not all individuals and businesses with lower credit scores who are emerging from the great meltdown are bad risks. Builders are getting back on their feet, people who lost their jobs are working again. They would build homes, they’d buy homes, they’d refinance high interest loans to take advantage of today’s historically low rates, and they’d pay the loans back – if only they could – but they can’t because of maybe 20 points on the hallowed credit score.
Sometimes you wonder: Did common sense die with the 20th century?
Pat Dalrymple is a valley native. He’s been in the mortgage and banking business since 1961. He’ll be happy to answer your questions or hear your comments. His e-mail is email@example.com.
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