In the US and most countries, credit scoring is usually the first thing that a mortgage lender does upon receiving a application. The importance of credit ratings in the mortgage industry cannot be undermined, that’s for sure. But are they as accurate and effective are they are said to be? Well, we don’t think so for the following reasons.
· Past behavior is not always a reliable indicator of future behavior
The basic concept of credit scoring is to use past patterns to determine future behavior and consequently the creditworthiness. It however, doesn’t account for psychological issues or outside events that might have occurred and affected the individual’s ability to repay.
· Credit scores are variable
In the US, three major bureaus deal with credit scores. They are; Experian, Equifax, and TransUnion. There are also thousands of sites that claim to show your credit scores for free, such as Credit Karma. Most of them get this information from the major bureaus while some use credit scoring software such as FICO.
It is very difficult to get the same score from all the bureaus since each of them has their own scoring methods. This discrepancy is even more on the free sites which usually provide equivalence scores which are far from accurate. As such, the lender cannot fully rely on credit score as an ‘Exceptional’ score from one bureau might just be a ‘Good’ on another.
· Mortgage is not ordinary credit
A mortgage is a long-term loan and usually matures in 10 to 20 years. Ordinary loans take less time to mature and are more likely to be defaulted. Additionally, the terms and interest rates in mortgages are very different from the ones in ordinary loans. Credit scoring doesn’t account for this difference and treats both of them the same way which affects the accuracy of the final score.
· Unreported loans
It is difficult for informal lenders to report debtors who have defaulted on payment. This means that a person may have a perfect credit score from one or two past loans, but still have unpaid debts owed to his local shylock, friends or family. For a mortgage lender, it might seem like a good idea to lend such a person since their defaulted loans are unknown, only to end up with a defaulted mortgage and unwanted expenditure such as repossession and real estate litigation costs.
· Conclusion
Credit scores are important, but should not be the sole determinant of creditworthiness. As such, mortgage lenders should incorporate other methods of ascertaining the credit risk such as net income, job security and tenure, and age among others.
References:
https://clubthrifty.com/credit-score-why-i-dont-care/
http://www.dicksonlegal.com/tacoma/real-estate-attorney/
https://www.creditkarma.com/article/monitor-your-credit
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