With thousands of mortgage loan applicants being rejected each year because their FICO scores label them as risky candidates, one online lender, Privlo, is working to offer loans to “nontraditional” borrowers who may be falling through the cracks.
Since its introduction in 1989 by Fair, Isaac & Co., FICO has become the credit scoring model most widely used by banks and creditors and is based on consumer credit files of the three national credit bureaus, Experian, Equifax and TransUnion. The exact formula for calculating FICO scores is a secret, but the scores assess various creditworthiness components, including payment history, debt burden, length of credit history, types of credit used and recent credit inquiries.
FICO scores have long been criticized as being unfair or inaccurate. A 2004 report from the Federation of State Public Interest Research Groups found that 79 percent of all credit reports contained errors. Recently, FICO, government regulators and others have been taking a closer look at the data used to compile credit scores and examining how they affect the creditworthiness of potential borrowers and mortgage applicants. Last August, FICO announced new scoring enhancements that differentiate medical from nonmedical collection agency accounts. And earlier this month, Department of Housing and Urban Development Secretary Julian Castro said the Federal Housing Administration (FHA) is exploring alternative credit scoring models for certain borrowers who may have thin credit histories or extenuating circumstances like medical debt.
“We do hear about the need to look at new ways of incorporating and analyzing data so that it’s more sensitive to getting at the responsibility folks have shown in their lives that would indicate — be predictive of — their future behavior and paying down that mortgage,” Castro told a dozen real estate and mortgage industry experts who attended NAR’s Credit Access Symposium, held April 1 at the association’s headquarters in Washington, D.C. “There’s been a disconnect there.”
Meanwhile, until a formal connection can be made, some mortgage lenders are working to extend a helping hand to borrowers who may be rejected for mortgages for a variety of reasons that result in them being labeled as “risky” credit candidates. Launched in 2011, venture and institutional capital-funded Privlo aims to meet the needs of borrowers who don’t fit the traditional lending mold, like self-employed workers and 1099 contractors; entrepreneurs; millennials with limited credit histories, nontraditional career paths or multiple streams of income; professionals who earn uneven bonuses or large commissions; and even foreign nationals in the country on work visas who plan to remain here for a long period of time or eventually become citizens.
Founder and CEO Michael Slavin agrees that FICO’s inadequacies “can cause maximum displacement of creditworthy borrowers.” He launched Privlo to address the problem of what he calls “misinterpreted” credit reports.
“We address bounce-backability of resilient consumers, true creditworthiness of young or thin files, true creditworthiness of customers that have been dragged through multiple collection agencies on minor balances, and one-time credit events that had a set of limited-time ripple effects, but have otherwise been clean throughout their histories,” Slavin said.
Privlo is designed to address more than 50 situations that could arise from these circumstances. For example, the company helped one millennial who had two credit cards, one auto loan and a clean credit history for 22 months, but was close to 100 percent utilization on a $1,000 credit line — which brought his FICO score down from 720 to 680.
“This is a borrower that works at a Fortune 100 corporation as a business analyst, who could not get an FHA or agency loan due to limited credit history and lower FICO scores,” he said.
Based in Southern California, Privlo lends in California, Colorado, Idaho, Maryland, Minnesota, New Mexico, Tennessee, Texas, Virginia and Washington.
“Most of these are also the states that have resulted in the biggest rebounds since the housing bust. Therefore, the underlying housing demand is very healthy in these areas as opposed to stagnation or declines starting in many states we are not currently licensed in,” Slavin explained.
Today, Privlo announced that it is adding Illinois to the list, where approximately a third of workers in the Greater Chicago area are self-employed, Slavin noted.
“When the recession hit and unemployment soared in the state, that Midwestern work ethic kicked in, and Illinoisans began starting businesses, turning to self-employment and freelancing,” he said. “No doubt, it’s helped pave the path to economic recovery, but it’s also left thousands of deserving borrowers out of homes. Most lenders don’t understand how to accurately evaluate those without a W-2 or typical tax return, and that’s where we excel.”
Although some worry that loosening the gold-standard FICO model will lead us back to the subprime loan and financial crises, Slavin said, “financial crises can happen only if poor due diligence is done by lenders.”
“Relaxing ‘top-of the funnel’ credit eligibility criteria need not imply poor due diligence,” he said. “By definition, due diligence happens after the loan gets into underwriting after passing initial credit eligibility criteria. It’s at the underwriting stage, where true good credits are unearthed. Secondary markets go by performance — either real or, in the absence of real data, simulated data. Our criteria and underwriting has been back-tested by our debt investors, and have been shown to produce tremendously good-quality portfolios had our criteria been used to originate the subprime mortgages of the past.”
Privlo plans to be active in 21 states, or 90 percent of the available market, by the end of the year. In the meantime, Slavin said he would like to see the mortgage finance industry and government regulators “reduce the number of products. Require every lender/creditor there to move to the latest version that’s supposed to correct for many of these factors. Create a separate credit score for an integrated tri-merged credit file, and make the mortgage industry use that one score to avoid all the vagaries that having three files and three scores entail.”
Privlo is backed by Spark Capital and QED Investors.