Millions to receive credit scores under new models, but expert warns of approval trap
New credit scoring models rolling out across the mortgage industry could dramatically increase the number of Americans who receive a credit score — but experts warn that borrowers shouldn’t confuse a number on paper with actual loan approval.
As credit repair specialist Micah Smith put it, "People with thin credit files … might be able to see a score … but that doesn't necessarily mean mortgage approval."
"It's actually being shown that about 33 million more people are actually going to have a score with these newer models, not approved," she clarified.
A few months ago, the VantageScore 4.0 model entered the mortgage market, competing directly with FICO 10T. The algorithms represent the two updated credit formulas federal regulators have approved for future mortgage use, each designed to paint a more detailed picture of a borrower’s financial habits.
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FICO 10T incorporates "trended data," meaning it looks back over time to see how consumers manage balances and payments rather than capturing only a single moment on a credit report. VantageScore 4.0, meanwhile, expands the types of information that can count toward a score — which is why it’s expected to generate scores for millions of Americans who previously had thin or incomplete credit files.
While both models modernize the system in different ways, lenders — not consumers — will ultimately decide which algorithm they rely on when evaluating a mortgage application.
"You're not gonna have the ability to choose between the two. So it's going to be up to the lender's discretion in regards to which algorithm they actually use," Smith said. "And so the biggest thing we want people to focus on is ... just continuing with the fundamentals and focusing on what has consistently, in the past, built a good credit score."
If someone’s score drops under a new algorithm, Smith offers a three-step triage plan, including everyday habits that could improve credit over six months to a year.
"Three tips that you can easily utilize to make sure that your scores jump up into higher tiers: One, we want to study the credit report and look for errors," she further advised. "Bringing down balances on credit cards is always going to move the needle … [and] what we would ask people not to do is don't make a rush and an irrational decision. Don't chase trends, don't look at gimmicks."
Smith pointed out that fellow industry professionals have expressed concerns that a potential shift toward a "too lenient" VantageScore 4.0 model could trigger a housing crisis similar to the one that fueled the Great Recession.
"The guardrails are in place now because we learned from 2008, 2009. And so, what we're seeing is that lenders are a lot stricter in regards to their criteria," the credit expert argued against any kind of collapse.
"When they were giving out these loans with no documentation, not doing a thorough study of who they were giving loans to, they were selling these loans off to Wall Street back in 2008, 2009, and there was no repercussion to the lender," Smith explained.
"Now, lenders are much more cautious, and they're doing their due diligence to make sure someone can actually afford to pay back the loans. So introducing a new algorithm, that's not going to be an issue. What would be an issue is being sloppy, and giving out these loans unnecessarily to unqualified individuals … Essentially, there's too many guardrails in place to cause a major crash."
As of Wednesday, mortgage rates are inching closer to sub-6% levels, as Zillow reported the 30-year fixed rate at 6.04% and the 15-year fixed home loan rate at 5.47%.
Smith cautioned against the biggest mistake consumers make when they hear a new scoring model is coming, emphasizing the risk of "falling forward" without understanding the details.
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"I think the biggest thing that I want people to understand when it comes to these new scoring models is pay attention to the narrative and who's pushing it out," she said. "No matter how flat you make a pancake, there's always two sides. And so don't blame the scoring model for, let's say, potentially a lackluster score. You have to understand that credit has a way of working and there are people to help you get there."
"When you get the score right, when you start building good habits, no matter which algorithm pulls it, you're gonna see a better score all around. And so it really does come down to the timeless habits. Don't place blame on these algorithms for an inferior score … Everyone makes mistakes. There's risks and there's drawbacks to everything, but fall forward into any sort of program that you sign up for. You sign your name on a dotted line, make sure you know the risks."