New York Fed: mortgage abstention distorts credit rating

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The pandemic is ebbing and the US economy is reigniting – in a lumpy way, of course.

This means that forbearance programs are due for an outcome. During the pandemic, lenders offered these programs to borrowers to ease the burden of payments on credit cards, student loans and mortgages in the face of job loss, illness and economic upheaval.

In an interview with Karen Webster, economists at Liberty Street Economics – the blog for the Federal Reserve Bank of New York – said the mortgage industry may have a role to play in distorting credit ratings. And now, more than ever, it is important to have a holistic view of the consumer / borrower.

Interviewees included Andrew F. Haughwout, senior vice president of the Federal Reserve Bank of New York’s research and statistics group; Donghoon Lee, a head of the bank’s research and statistics group; Joelle Scally, senior data strategist in the bank’s research and statistics group; and Wilbert van der Klaauw, senior vice president of the bank’s research and statistics group.

In a report titled “What Happens During Mortgage Forbearance?” The agents discovered, through their research, that since March 2020, more than 6.1 million mortgage borrowers have gone into forbearance. These forbearers were “much more likely” to be delinquent before the pandemic than was observed in the general population of mortgage holders. About 8 percent of borrowers were in arrears before entering forbearance programs. About a third of previously overdue accounts were still overdue.

This raises the question of the impact of credit scores – and whether we need a new credit scoring system.

At a high level, Scally said, the forbearance program has been “very successful, in that it has protected consumers’ credit reports from widespread damage and allowed people to stay up to date on their loans. “.

Risk signals for lenders

But that’s where lies what, on the surface, seems like an enigma. Data shows that around 4% of mortgage borrowers could become severely delinquent – less than what was seen during the Great Recession, but still troublesome as their status has yet to impact credit reports. So lenders may not yet see the risk signals associated with these borrowers, as forbearance is a neutral event in terms of credit and can lend money where they shouldn’t.

But as Scally noted, many mortgage borrowers, without having to make payments on their properties, were able to save funds (the stimulus payments helped) and in so doing, reduce other debt. Thus, all other things being equal, they should be able to assume the repayments when they exit forbearance.

There has been a tailwind of rising credit scores due to non-mortgage debt. Lee pointed out that the credit rating increases seen in the midst of the pandemic came, in large part, as federal student loan debt (about 85% to 90% of the total amount outstanding) turned into forbearance.

But there are enough signals that lenders can see post-pandemic risks clearly enough.

The sticking points are that at least some borrowers, before the pandemic, already had at least one account in collection, and as Lee put it, “if you have 10 negative records and one goes, nine negatives will remain. records. “

The eventual exit

As for the possible exit from forbearance in the mortgage sector, we will see two “tracks” of activity.

At least some of these borrowers leave the program by selling their properties, eliminating these borrowing entirely. Lee noted that lenders have worked with borrowers amid forbearance to structure the exits that make the debt that’s still on the books more manageable. In many cases, payments that were skipped, Lee said, are “added” to the end of the mortgage, so in a general illustration, a 15-year term would become a 16-year term.

Don’t expect refinancing to make a comeback, van der Klaauw warned. People who struggled to make their mortgage payments before the pandemic are unlikely to suddenly be eligible for refinancing due to their credit rating rise due to forbearance.

“We haven’t really seen any evidence of an increase in claims just because people’s credit scores are going up. They may not even know that their credit rating has gone up a bit, ”said van der Klaauw.

Haughwout added, at least this time around, the traditional FICO score may not reflect – at least, “not very well” – what happens during a pandemic, as it’s not a typical recession.

As he told Webster about those who went for forbearance and the FICO score: “Does that give a lot of information about their future ability to pay off their debt? I am not sure this is the case.

Credit scores, Lee said, are evolving and can be adjusted (with new algorithms) to reflect the times (and as has been widely reported, banks are reducing credit rating requirements for some loans). The old 620 isn’t the new 620, after all.

As for what lies ahead: more data points will help lenders make more informed decisions. Haughwout said research shows investors in the housing market at the turn of the millennium had high credit scores – as they reaped and paid off dozens of mortgages. But of course they were burned down in the real estate crash (and didn’t have the motivation to pay back because they didn’t live in the houses with their families).

“It’s important for the lender to look at the entire credit report, not just the credit score,” he told Webster.