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AAA CREDIT BUREAU PRESENTS: AAA INSIGHTS
In this inaugural addition, credit scoring and borrower rights pertaining to their credit report are discussed. In the following issues, other topics relevant to the mortgage industry will be covered. AAA Insights is dedicated to providing insightful and substantial information to our customers and the mortgage industry as a whole.

CREDIT SCORING AND CREDIT SCORES
Credit scoring has been utilized by lenders for over 30 years. Credit scoring is a technology used by credit grantors to qualify the risk associated with extending credit to a given borrower. Risk is quantified by means of a score card which calculates a numeric value, or score, for a credit applicant a lender wants to evaluate. Score calculation is done based on information that has been determined to be indicative of future credit performance. There are many types of scoring methods currently utilized today including credit scoring, applicant scoring, behavioral scoring and several others. The type most relevant to the mortgage industry is credit scoring and among the most widely recognized is the FICO SCORE.

FICO scores are derived from predictive scoring models that are housed or reside at the three national credit repositories, TRW, TRANSUNION, AND EQUIFAX.

The Fair Isaac company (a company located in San Rafael, California) is the developer of the models for the credit bureaus and though each credit bureaus model differs slightly and have different names (TRW-FICA, Transunion-Emperica, Equifax-Beacon) they have become commonly known as FICO SCORES.

MODEL DEVELOPMENT
To insure that representative samples were selected in the development of the FICO models, Fair Isaac compiled millions of credit records from each of the three credit repositories across the United States. Each record included credit reports from two previous points in time, 24 months apart. The earlier credit report was then compared with the later report and the credit performance which occurred during the intervening time 24 month period was evaluated. Based upon the evaluation, each credit file was assigned one of several broad categories in which these categories isolated various levels of satisfactory and unsatisfactory credit performance. Further analysis was conducted and factors in the credit report that were determined to be the most predictive in nature were selected and used to build the credit models. Some factors were deemed more important and predictive than others and therefore, assigned the appropriate weight, or value in the construction of the model.

Each of the three credit bureau scoring models contained 23 to 25 characteristics that in essence, make up the model. While Fair Isaac holds the content of the models as proprietary and strictly confidential (even the repositories do not know the exact content of their models) you can get an idea of them by examining the adverse action or reason codes that accompany the FICO score.

Examples are:

Excessive amounts owed on accounts
Two many consumer finance accounts
Insufficient length of credit history
Too many recent credit inquiries

These are actual reason codes provided by one of the credit repositories. These and others provide insight into the content of the models. It also lends insight into what is impacting the FICO score the most, usually in a negative manner. The bureaus deliver up to four reason codes when posting a FICO score on a credit report. These reason or adverse action codes (some credit institutions use the actual verbage of these codes to deny credit to an applicant) are the primary factors contributing to the compilation of an individuals score. If these factors are addressed, the FICO score can usually be impacted in a positive manner. Be very selective who you authorize to run your credit. Almost every time you apply for a credit card or loan, your credit will be accessed and your score will be lowered. Why does the score seem reasonably low?

The bureau may have duplicate information. This causes reduced scoring. Why a zero score? Not enough credit, too much derogatory credit, or no activity of any kind in the last 6 months.

As mentioned previously, each of the three national credit repositories house their own FICO model on their systems and as a borrowers credit file is assessed, it passes through the model and a score is generated. Therefore, in order to change a credit file score, The content of the file must be altered in the repositories data base. Updates and verifications that AAA American Credit Bureau makes during the mortgage origination process will not effect a borrowers scores since the three national repositories data base has not been refreshed with this new information. It is up to the BORROWER to go through the "CONSUMER DISPUTE PROCESS" to effect changes to their credit report as well as their credit score. Therefore, upon completing the dispute process, any items updated will impact a credit score. For example, collections erroneously reported unpaid that are then rereported as paid, will give a lift to the credit score. While it is extremely difficult to determine the impact of such actions on a credit score, the action is consistently positive and can help borrowers qualify for loans that were previously out of reach. No single repository has all of a persons credit history. Bureau files differ based on geographical areas. TRW may be the strongest bureau in a particular area,

while TRANSUNION is the strongest bureau in another area. If a bureau score is thought to be higher than another in a certain area, this probably because that bureau is reporting less credit.

FTC released September 1, 1995 "The Federal Trade Commission said that federal law does not require credit bureaus to disclose risk scores to consumers" who request copies of their credit reports. They also set forth the substantial cost of providing and explaining risk scores, and questioned whether more consumers might be confused when confronted by an array of scores and explanations then would benefit from seeing them.

SCORING ENDORSEMENT
Why has credit scoring taken hold in the mortgage industry? The primary force driving this phenomenon is the endorsement given credit scoring by the largest mortgage investors in the United States, FNMA and FREDDIE MAC. Both issued letters in mid 1995 stating their verification of the use of credit scores was a valuable tool in evaluating credit risk. Both have endorsed Fair Isaac's "delinquency predictor" model (commonly referred to as FICO scores) and MDS/CCN'S "bankruptcy predictor" model. Each utilize a score range that calculates relative risk. The Fair Isaac

range is approximately 380-830 where higher scores relate to lower risk and low scores are associated with high risk. Conversely, the MDS/CCN model associates high risk with high scores and low scores with low risk. Its score range is approximately 0-1000 plus, however this model is far less utilized in the mortgage industry than are the FICO models. In addition, both FNMA and FREDDIE MAC have determined certain "cutoffs" that they also endorse. For example, both agreed that a FICO score less than 620 would indicate a need for a cautious, detailed review of a borrower's credit history in order to identify compensating strengths to offset the low credit score (high income).

CREDIT SCORING: ITS HISTORY AND FUTURE
While credit scoring has a proven track record and has been around for years, it is relatively new to the mortgage industry. Since the previously discussed models do not incorporate such things as income, down payment, amount of time on the job, and other factors unique to our business, debate continues on the use of these models in the origination process. However, one thing appears certain...credit scoring is here to stay in the mortgage industry.

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