Easing GSE credit score requirements raises risk concerns

"However, there's a reason the GSEs had such requirements in place for decades. They acted as an important override against errors in the analytical underwriting models that may not be able to distinguish between loans that are likely to default or not for certain types and thresholds of risk attributes. Loans with credit scores below 620 pose significantly higher default risk to credit investors, and consequently, the 620 credit score cutoff became a well-known benchmark for subprime lending used by the industry, including the CFPB."

"With the advent of automated underwriting in 1996, the GSEs revolutionized the mortgage lending process. It ushered in an age of quantitative modeling where a machine could effectively ingest a large number of borrower, loan, property and other risk attributes simultaneously and determine within a second the likelihood of default for a borrower. But these models had an Achilles heel; their ability to distinguish between good and bad loans was dependent on the historical data fed to it."

Eliminating minimum credit score requirements in GSE automated underwriting would expand access but materially increase credit investor losses. Loans with credit scores below 620 carry significantly higher default risk and became the industry benchmark for subprime lending. Both GSEs maintained minimum score thresholds on Single-Family loans through the mortgage boom despite other risky retained securities that contributed to conservatorship. Automated underwriting enabled rapid, quantitative risk assessment by ingesting many borrower, loan, property, and other attributes. However, model accuracy depends on historical data; insufficient performance data for borrowers below 620 leads to estimation errors and higher potential losses.

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