If you pay all of your bills on time and have a pretty high credit score, you qualify for the best mortgage rates and terms when you get a home loan. But are you a better risk than someone with a fair-but-not-great credit score? Lenders have discovered that while credit scoring models were good at picking out the truly horribly risky applicants and the absolutely stellar borrowers, they were only so-so at sorting out the vast majority of folks in the middle.
Consider too that those who never missed a payment in their lives but who lived in a depressed area, lost jobs, and ended up in foreclosure or bankruptcy will be considered subprime for years even if they go right back to paying on time once their financial problems have been resolved. But are they really subprime or just unlucky?
If lenders don't figure out a way in the future to sort out the truly risky from the fairly solid, purchasing could be very tough for a lot of people, and that could drag the economy down for many years.
What Makes a Solid Borrower?
New proposed credit models would take the economy as a whole into consideration, cutting people some slack when times are tough and softening the effect of financial hiccups on credit scores. In good times, a late payment would have more impact.
Other trends in underwriting, however, involve considerations that have nothing to do with the borrower's character or financial strength.
For instance, lenders may make underwriting decisions by factoring in the local economic climate. So someone being transferred into a depressed part of the country may have a harder time getting a mortgage and buying a home there than he or she would otherwise. Fannie Mae came under fire for effectively redlining whole cities or states by declaring them "distressed areas" and subjecting them to stricter underwriting guidelines and increased fees. Redlining is illegal and involves lenders treating borrowers in poorer neighborhood differently than those in better-off areas.
Finally, rates are up in non-recourse states (analysts estimate that borrowers in those states pay an extra $800 for every $100,000 financed) because it's easier for borrowers there to walk away from underwater homes; mortgage rates in California or Washington are higher than mortgage rates in Utah.