Mortgage Credit Scoring Update: VantageScore, Classic FICO, FICO 10T | March 31

Jim Glennon (: 00:01

Welcome to Optimal Insights. I'm your host, Jim Glennon, Senior Vice President of Hedging and Trading Operations at Optimal Blue. Our clients and industry partners have long relied on Optimal Blue for trusted insights and commentary. And these podcasts are an evolution of our commitment to keeping the industry informed. Let's dive into today's episode.

Welcome everybody. As always, I have a great show for you this week. we begin, I wanted to draw your attention to something pretty interesting. Optimal Blue just completed basically an ROI.

study. The key findings of that study, they're out right now. You can check them out on our website, but more good stuff to come from that report. The objectives of the study were to quantify real economic value of using optimal blue products, basically. So demonstrable ecosystem level impact on your mortgage operations. So essentially an operational and financial impact study. So yeah, go check it out. It was done by a third party. I think that just did a really nice.

Really nice job with Okay. Getting back to it in the interest of making sure you know what to watch, whether you're an originator, a capital markets person, or just someone interested in the mortgage industry and some great market commentary. We're going to get into a couple of subjects today. We're going to talk market, of course, with James and Alex. And then after that, Alex and I are going to chat a little bit with you all about this kind of credit reporting saga that is taking place right now. So if you've heard

people talk about FICO 10T, you've heard people talk about Vantage Score, you've heard Pulte, for instance, tweet about the ability to use some of these new models, especially Vantage Score for scoring, qualifying pricing mortgages. So Alex and I will talk about that here in a little bit. Before we get to any of that, just in the way of data, as you know, since the beginning of the Iran War, rates are up.

Unfortunately, and spreads have widened as well. So the 10 years down a little bit at 4.33 compared to last week, but the OB-MMI is still right around 6.5%. So higher than we've seen it in many months. And again, the war has a lot to do with that inflation expectations, that sort of thing. We'll talk about all that in a moment. And spreads are widening between the 10 year and the mortgage, unfortunately. And that has pushed volume down. So let's talk with Alex and James here in a moment and see what's going on in the market.

Jim Glennon (: 02:41

All right, welcome gentlemen. Hey Alex, hey James. Thanks for being here to talk today.

Alex Hebner (: 02:44

Good morning.

James Cahill (: 02:46

Yeah, good morning.

Jim Glennon (: 02:48

Okay. Where to begin? We are 30 days into the war with Iran. Not a ton in the way of developments in the actual war, other than more organizations getting involved. as you might expect with this sort of conflict, you start having pods or cells of other organizations starting to, I don't know, create

their own problems in some of their enemy countries or they're attacking us in other countries, our interests and our bases. But anyway, 30 days in, I mean, where do you see it this week? I mean, that's what's dominating the headlines, therefore what's dominating the market, right?

Alex Hebner (: 03:23

Right.

Yeah, it's, we can keep this somewhat short, but in regards to week over week changes in this conflict, there hasn't been a ton, there's little flirts of peace deals being offered out on social media. I'd get to see anything that looks really substantive on that, although I think we won't know until it's just about And then in regards to the conflict itself, it's continued kind of a pace, seen some slight expansions there, the Houthis in Yemen who are Iran.

linked group. They've begun launching their own drones and missiles. There's some militias in Iraq doing the same towards US bases in Israel. then there's a concurrent operation that Israel has ⁓ launched against Hezbollah in southern Lebanon. So, you know, all these things just continue continuing same as they were last week. ⁓ I think, you know, as someone based in the US, you know, what to keep an eye on here is really that price of oil. It's going to continue to, you know, melt up.

the longer the strait remains closed. As we covered last week, the US has better insulation against this strait closure than Asia and Europe does, but it's gonna have global impacts and those impacts are gonna grow by the day as the conflict continues.

James Cahill (: 04:45

Nut oil price, as of recording, it's sitting at about $113 a barrel. This is really the highest we've Looking into stuff like this, was mixing laughs that it's highest served in since 2022, which is not that long ago, but that was when Russia, Ukraine broke out. And then if you want to see a level about that high prior to that date, it's 2008, a spat in 2011, but...

you know, it's all of sudden it becomes a decade since we've seen this. It just the last five years has been such a such a rush. But that one hundred and thirteen dollar per barrel, it's it's really pricey. That is not really a long term sustainable price that we want to be seeing.

Jim Glennon (: 05:30

Yeah, as we've talked about, you know, it's up 30, 40, 50 % oil. And that translates to obviously higher prices at the pump, but also higher prices for everything over time, right? Transportation of goods, expensive services. So it's changed expectations significantly in terms of where interest rates may be later on this year. In fact, you know,

rate cuts seem off the table at this point. Certainly that's how you would read the CME futures and just listening to what the Fed is saying recently. In fact, it looks like there's a better chance of a hike than a cut at this point. There's almost no chance of cuts later on this year, but there is maybe call it even. Like there's just as much of a chance of a hike as a cut. If you go out until like second half of this year, which is a far cry from where we were before this war started.

Alex Hebner (: 06:27

Absolutely. Yeah, the CME FedWatch, it's flat all the way out through mid, if not late 2027 at this point. think we're going to get greater direction on that once the fighting itself actually stops. think everyone's really in a holding pattern to see how long this damage to energy markets is going to last.

I hear the same thing you do, Jeb, of there's whispers out there of, you know, if inflation really does take off, that rate hikes could be necessitated by that.

James Cahill (: 06:56

at the beginning of all this, we said it was, know, there's a four to six week timeline before energy shock should actually start more so showing up just because of how much the length of time it takes to turn these pumping facilities back on to get oil back through. And so here we are at week four, we're bleeding into week five. That puts us, you know, is it gonna end in the next 24 hours, 48 hours before we should see some of this bleeding through? That's really what's pushing.

might be more price shocks coming, there might be inflation, maybe we're going to see a rate hike with everything. We haven't really gotten the rates or unemployment or inflation exactly where we want it to be. So it's a little bit sketchier now. We might see a rate hike is why that's starting to pop up.

Jim Glennon (: 07:43

Right. Meanwhile, long-term rates up about half a point since the war started, as we've said, right? So you get OBMMI is about six and a half percent. Ten years, about four and a half percent. So between the inflation expectations and even just the extra $200 billion that the president wants to spend on this war, like all of these things are adding to what would be a supply of debt, which as we know will cause yields to go higher so that those yields will attract.

investors.

Okay. So what about the microcosm of this short Easter week? As y'all may or may not know, it's kind of like a four and a quarter day week this week. Friday is the market is open on Good Friday, only open for bond markets are only open for four hours, right? It's a kind of a half, half day noon close Eastern time on Friday, partially because there will be

A jobs announcement. There will be an unemployment report that comes out at the usual time on Friday. And that's another thing to keep an eye on because the jobs market is obviously the other half of the feds mandate. Last month, so the February jobs report that came out in the first week of March was the first to show a negative non-farm payrolls number. So this time around, we may be expecting

Are we expecting something in that range or something small, something close to zero?

Alex Hebner (: 09:20

The expectations in the positive range, but it's in the range that we would have expected out of a pre-COVID non-farm number. It's expected around 45,000 this time around. As you said, Jim, was sharply negative, close to negative 90,000 last time around. There were some labor strikes in there that kind of muddied the water on that. Those jobs will come back on this But even without those, it still would have been a negative release.

the conflict in Iran, this has kind of gone by the wayside, but the labor market was what we were concerned about, you know, in February and January, and if there were cracks there, and, you know, if they were beginning to show, and how long those disruptions from AI could be. You know, that's what we talked about the whole back half of last year as we saw inflation taper off into two point something. ⁓ So this could be a sneaky, impactful labor report, in my opinion, just because it's going to bring back some of those

Jim Glennon (: 10:06

Mm-hmm.

Alex Hebner (: 10:14

domestic questions that we've kind of stopped asking as we all read the headlines day after day.

Jim Glennon (: 10:20

Sure.

James Cahill (: 10:21

Yeah, as you know, we've all been talking again about inflation, maybe a rate hike, right? Looking at those numbers with the report coming out this week, the unemployment rate is probably going to go from 4.4 to about 4.5%. So creeping up definitely the wrong direction for this. It's still not any sort of critical level, but as long as it keeps moving in the wrong direction and inflation potentially moving in the wrong direction, that's ⁓ that's stagflationary. We definitely don't want to see that.

Jim Glennon (: 10:51

Right. That four and a half sort of psychological barrier seems to be where the Fed really starts to pay attention, right? Like you said, it's not critical at four and a half, but if we keep moving a tenth of a point in that direction each month, you could see that the Fed being compelled to make a move if we get closer to anything close to 5%. I think four, six, four, seven. We're really in a market that is shrinking at that point, an economy that's shrinking or that the very least it's stagnant.

which is not what the Fed wants to see and certainly not what the administration wants to see.

What else are we looking forward to this week, gentlemen?

James Cahill (: 11:31

I have the ADP jobs report coming out as well. So just a little bit more jobs information a little earlier. They tend to be a little more volatile than the actual numbers, but in this past year, they were predicting shocks before the official numbers did. So it's a good look at, hey, these are some maybe worst case scenarios.

Jim Glennon (: 11:53

Right. Right. Yeah. That number has been increasingly relied upon, think, especially with some of the, don't know, disbelief with some of the numbers that come out of the Bureau of Labor Statistics. Certainly the White House had some issues with those numbers earlier on ⁓ in the current administration to the point where they replaced some of the high ranking members of that.

and who knows if they've actually made significant improvements there where they felt like it was lacking.

James Cahill (: 12:26

Yeah, and with the government shutdowns that have happened this year, it's just become slower to get the government reports.

Jim Glennon (: 12:35

Okay, great. So not a super busy week in terms of numbers, but some big ones. So we'll see the big unemployment report on Friday, likely some news about the war this week as well. Hopefully some good news about a possible de-escalation or even some sort of delay or stoppage in the fighting. And then we'll really find out what that means long-term for the market. All right. Good market update. Thank you gentlemen, as always.

Have a good day.

James Cahill (: 13:05

Thank

Alex Hebner (: 13:05

Thank you.

Jim Glennon (: 13:07

All right, Alex, ⁓ something I wanted to cover today. We covered it actually on a webinar, mid last week, and we get a lot of questions on our trade desk about it. We're getting questions across optimal blue, because this is basically it's a growing issue out there on things like LinkedIn. So you hear a lot of chatter there and elsewhere. You can't go to a conference right now in our industry and not have a panel that is focused on changes that

have come and are coming to credit reporting. not the most, maybe not the most interesting subject on its face, but it actually, there actually is a lot of interesting stuff going on with credit reporting right now that's not super in the weeds even. It's kind of almost like an exercise or a lesson in economics, the way that it's being, the way it's playing out right now. So what we're talking about, you may have heard that there are changes that have come and are coming.

for credit reporting, especially for mortgages. So just the backdrop, in case you're not familiar, FICO score is what we would call it, right? FICO stands for Fair Isaac Corporation that they've been kind of owning the credit reporting for mortgages for decades. So mortgages are priced, valued. Your ability to repay is based on what they're now calling classic FICO.

because there's these new models now. So we're calling it Classic FICO, which is kind of old school, been around for decades. It's a tri-merge kind of situation, right? There's three credit bureaus that report on your credit, on any individual's credit. And you take those three scores that FICO runs an analysis on what comes from these credit reporting agencies. And then you basically pick the middle. If you have three scores, you pick the middle of those scores and that's your credit score for the purposes of getting a mortgage loan.

So jump ahead, and this is where there's a bit of history that's been out there for quite a bit. Alex and I were just talking, right? This goes back to the credit crisis, right? The aftermath of the credit crisis. What happened there that kind of woke people up and said, maybe we should revolutionize or at least modernize or at least look into this credit scoring mechanism that we've been kind of just following without questioning it since I believe the early eighties.

Alex Hebner (: 15:32

As you said, ⁓ in the wake of the global financial crisis, ⁓ politicians, those in Washington, DC, ⁓ really took a magnifying glass to everything in the mortgage industry. And credit reporting and FICO scores, credit scores themselves came under that microscope as did everything else. And what came out of those investigations,

Jim Glennon (: 15:43

Mm-hmm.

Alex Hebner (: 15:55

culminated in the Score Competition Act. know Tim Scott and another sender from Virginia co-sponsored it. It was passed in 2017 and essentially what it did was it codified the ability for the FHFA to approve or deny alternatives to the classic scoring model. this has been a very slow roll. They didn't get this act out until nine years after the

et. Since then and since that: 2017

Jim Glennon (: 16:41

Mm-hmm.

Alex Hebner (: 16:48

seen advantage score be deployed. Now this ⁓ is another credit scoring model that is used on borrowers and it was co-created by those three credit reporting bureaus that you talked about. Experient, Equifax, and TransUnion are the three. And their model was approved by the FHFA couple years ago now ⁓ to be used alongside.

Jim Glennon (: 17:03

Mm-hmm.

Alex Hebner (: 17:12

classic FICO. So in theory for a conforming loan, you could utilize ⁓ either a classic FICO or the Vantage score. we've just seen a slow adoption ⁓ of that Vantage score as it's taken a little bit more market share in that credit reporting space where previously it was fair Isaac or nothing.

Jim Glennon (: 17:34

Right. It has caught on a little bit, but there's still some hurdles to jump over. I think it's also worth noting that one of the reasons that everyone, a lot of folks in the industry, and then the current White House administration has been fairly vocal about the adoption of Vantage score is pricing. Right. A big thing was that FICO, because

It was the only game in town was able to raise their price over time. Some would say significantly, some would even say maybe more than was reasonable to the point where it's not a major expense when originating a mortgage. costs between 8,000 and $12,000 to originate a loan. And a credit report costs between, I believe it's like 80 and $200. But nonetheless, that's a price that's gone from $5 to 10 to 50 to 100 over time.

So the current administration got ahold of that. You also have very vocal people on LinkedIn, other folks, activists in the industry saying that something needs to be done about the cost, but also what we talked about earlier, just the fact that FICO has not been overhauled in many years. ⁓ like you said, enter Vantage score. Vantage score takes hold. A few hurdles there is, like there's not a lot of guidance yet from the FHFA. ⁓

or Fannie Mae or Freddie Mac on what to do with that score. how is it going to be used to qualify a borrower? And just as importantly, how is it going to be used to price that loan? Meaning how do you use it to establish an interest rate? Because right now you really only have Classic FICO to use the price alone. And because we have so much history of these credit scores, as you said, for the past 30 years, it's been used. Therefore pretty much every mortgage that's out there right now was

originally scored using FICO. Therefore, we know the delinquency rates and the payment performance of all of these trillions of dollars of mortgages just purely based on FICO score. So that's one chicken and an egg kind of thing that I think the industry is going to have to deal with for a while is that there's this lack of history for vantage score, because it hasn't been around that long. It hasn't been especially for GSE loans and government loans and this sort of thing. Although there's been a handful of,

FHA pools, for instance, that have used Vantage Score. So you have this competition that's starting to bruise. You have Vantage Score, you have Classic. So then FICO though also comes out with their own new version of credit scoring. Right? So you have FICO 10T, they call it. And that, as I understand it, works similarly to Vantage Score in a few ways. One, like it basically is meant to...

address some of the, maybe not deficiencies, but some of the things that could be better about FICO, you know, having been developed 30, 40 years ago, obviously there's better technology now, there's better data. There's some things that are lacking in a classic credit score that are going to, that are being addressed by VantageScore and FICO score 10T, right? Some of those are trending for instance, like FICO score is just kind of a snapshot in time where

Banage score and FICO 10 T look more at a person's credit over time. Are they trending worse in credit? You know, are they accumulating more debt? Are they missing payments over the past six to 18 months? Or are they getting better? Like that could be good for a borrower if their credit score is improving, but it's not quite to the, I don't know, levels yet. It will take that into account. So that's just a couple of things that are being addressed by these new credit scoring mechanisms. And I think the other one would be rent, right? Alex.

Rent is, or other types of, they would call it thin credit. Some borrowers just don't have a ton of stuff on their credit report to evaluate them. So these new mechanisms bring in additional data that the current classic FICO score doesn't.

Alex Hebner (: 21:39

Absolutely. Yeah, I there's two big changes to these new and improved credit models that improve upon that classic FICO. One, as you said, is that trend of data, it's no longer a snapshot in time. can show if you as a borrower have been improving or degrading in your borrowing habits and your ability to make payments on time. other is that there's a recognition that the economy has changed the last 30 And there's also, I think, a tacit admission that we want to expand.

the pool of people who are able to be scored and achieve that American dream of owning a home. And so, like you said, they've opened the circle a bit of the items that make its way onto that report. ⁓ As you said, rent is one of those items. ⁓ So you can show that you're a responsible renter, that you make your payments on time. That goes a long way towards proving that you'd be able to.

make your housing payments when it comes to a mortgage as well. Utilities are on there as well. And then there's also some exclusions in some of the models. There's the Vantage Score one, specifically excludes medical collections. Medical debt is major source of debt for Americans. And they've made the decision on that particular model to exclude that.

Jim Glennon (: 22:55

Interesting. Yeah, that's always been kind of the exception to the rule, the medical bills, because at times just with kind of how screwed up our healthcare system is, you can end up in unavoidable debt from a medical bill. that's usually the one, if you can't afford it, that's the one you don't pay, right? You stay current on everything, your car, your house, your credit cards, but that's the one that was unexpected, I suppose, it could be huge.

So lot of folks will let those lapse and sometimes rightfully so, because they're just, it's too large of a bill to pay. So it's interesting that they would exclude those because it doesn't necessarily mean that you're a poor credit recipient. It just means that you kind of got yourself in a tough situation for good reasons.

Okay. So yeah, I mean, as far as, you know, what to think about if you are, if you're an originator, you likely already know about this saga. You're likely on LinkedIn, maybe even opining on this. You've seen the tweets from Pulte, the chairman of the FHFA coming out and saying, you know, the score is eligible for GSE delivery immediately. Right. That's what got, I think this really in the public eye.

last year, because again, politically speaking, there's a lot of motivation to back the vantage score, becoming a major competitor to FICO for the pricing reason, for the quality, right? Just to create competition to force FICO and any other competitor that comes to just to create something that's better. So in that regard, I think it's a good thing. It's just, you know, when will we be able to actually price loans and use these new mechanisms?

in our day-to-day lives as mortgage originators, as borrowers, as capital markets people, we don't know the answer to that yet. The adoption's there for things like pre-qualification. We've heard a lot of clients use it to pre-qualify a loan for loans that are in their portfolio, potentially meaning a loan they did years ago that they own they want to continue pulling credit on that, partially because of the score is less expensive, but also because it is a trended analysis so they can kind of get a better view into what the...

how the borrower is performing. So the next step is just going to be the GSEs and investors. So investors meaning big banks that buy mortgage loans, having them publish pricing that's for advantage score and possibly for FICO 10T so that those two models then can move forth. And eventually I think the plan would be for FICO to eliminate or retire classic FICO because they're also working on some even newer models than FICO 10T for other types of.

of mortgage loans.

Alex Hebner (: 25:44

agree with all those statements. think we'll see here in maybe in the five to 10 year time span, we'll see a pretty healthy ecosystem of two coexisting FICO scores. But I do think right now, as you said, the big barriers are on the investor, the street side of getting enough data to say, to accurately be able to price those vantage scores as they retain more and more of those.

Jim Glennon (: 26:08

Right. And I guess, you know, one thing I would note that has not been addressed by either of these new models that's always bugged me, even looking at my own credit or when I was on the origination side of the business is if you've ever noticed, if you've ever had your credit pulled and you get three scores, they could be very different from one another. Right. So whether you're Vantage or FICO 10T right now, they're still getting their credit scores from

the credit reporting agencies, as you mentioned, the three different agencies. And somehow those, those three bureaus are supposed to have the same scoring model, generally speaking, but they don't always have the same data. Meaning you could have 10 trade lines, a trade line would be like a credit card mortgage, a car loan. You could have 10 trade lines with one reporter and then seven with another and 12 with the third. And those are going to be

at various points of maturity and you have different balances on those. So you can have a credit score of 740, 760, and then like 720. And to me, that's frustrating. That feels like something that should be addressed at some point. If the data is just bad, what's, how is that model, that model's going to be, the model could be better. Let's put it that way. If the inputs were, were cleaned up. Anyway, I didn't want to rant about that, but I did want to mention it because it is kind of an important point that.

should be one of the things that I feel that should get addressed here at some point to really fine tune the quality of these reports is having all of the trade lines that are available in the reports.

All right. So yeah, I mean, if you're curious, definitely go out and read more about this. Copilot will give you a good, know, or whatever AI machine you use will give you a good view into this. Cause it is kind of everywhere. LinkedIn has some pretty good, about it as well, but otherwise just, if you're in our industry, keep, keep watching. think later this year, I would expect the GSEs to make some sort of announcement about how to price these, but that's going to be.

That's going to be a whole nother can of worms that we'll have to open and deal with because it's still not clear if I'm an originator, if I have to pick a lane, like I'm a vantage score shop or I'm a FICO 10T shop or I'm a classic, or am I going to pull all three for every loan upfront? You know, some folks are already doing that just to kind of test the waters, what does the vantage score look like versus classic? That doesn't address the cost issue. That would make it more expensive.

but it could give you the opportunity to pull three different styles of credit and therefore pick the best one to give the borrower the best rate. That could be good for the borrower. In fact, with a rate that's lower, that could arguably more than make up the cost of what a credit report costs the borrower. that, you know, maybe the argument is there that you pull all three and you find the highest one. Anyway, more to come. We really don't know a ton other than what we've just told you and the internet won't tell you a whole lot more, but.

I do expect news on this and when that news comes out, we'll certainly talk about it again on the podcast.

Alex Hebner (: 29:17

Absolutely, absolutely. Yeah, the mortgage industry is kind of late to the party when it comes to these. You you see much wider adoption of the newer models other credit spaces, whether it's auto lending credit cards and such. to come for sure.

Jim Glennon (: 29:32

Yeah. I they're clearly better. There's clearly an improvement. It's just a it's a big boat that we have to turn around in the mortgage industry. think there's so much, there's so many vintages of loans that were scored against scored on classic FICO that they know what that performance looks like. Even if that's not the best way to score today, it was the only thing for the past 30 years. So that's what, that's the history. That's the historical data we have to work with. So just making that jump, making that transition to these newer models is going to be.

Alex Hebner (: 29:40

Yes.

Jim Glennon (: 30:03

It has its nuances, especially for the largest credit industry in the world.

Alex Hebner (: 30:10

Absolutely, a lot of plumbing to be reworked.

Jim Glennon (: 30:13

Definitely. All right, Alex, great discussion, man. Appreciate you. Talk again soon.

Alex Hebner (: 30:19

Appreciate it, Jim. Thank you.

Jim Glennon (: 30:21

Okay, let's wrap this thing up. Thanks so much, Alex. Thank you, James. That's it for today. Join us next week for another episode of Optimal Insights, where we'll continue to provide you with the latest market analysis and insights to help you stay ahead. Check out our full videos on YouTube. You can also find each episode on all major podcast platforms. Thanks again for tuning into Optimal Insights.