Friday, December 14, 2007

FICO Scores for Mortgages

I have never been a fan of credit scores. Miss a payment and your score falls dramatically but once you cure the problem the score increases very slowly. This reminds me of the way Congress presents tax increases or reductions; a $1000 a year increase is a "slight" increase whereas a $100 cut is a "dramatic" reduction.

Back in the 1980's I worked for a finance company which designed one of the first credit score systems. We were sued and lost the law suit and had to quit credit scoring. I was surprised when 10 or more years later the entire industry started using credit scoring.

Back to mortgages. Years ago I studied risk analysis for credit and determined that foreclosures are the result of (1) loss of job or income reductions (2) a major medical situation and (3) divorce. These are things that cannot be shown in a FICO score.

Today there was an article with stats from Countrywide that again reinforced my belief. Countrywide stated that 60% or their foreclosures are the result of a drop in the clients income. Sickness and divorce add another 20% or more. Way down on the Countrywide causes-for-foreclosure list, just under 2%, is payment adjustment.

We have a subprime crisis and it is interesting because so many of those subprime loans were approved on credit score alone. There were 100% loans approved with no proof of income so long as the borrower had a high credit score. If the loan was 100% then the loan to value was not a criteria for making the loan; if there was no proof of income, then the debt ration was not a criteria. Therefore the only criteria for making the loan was credit score alone. What a silly way to do business.

Doug Jones