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Credit-score cutoffs need recalibration to reflect current default risk.

Credit scores don't stay constant in terms of the default risk represented by a borrower with a particular score. That is what some credit-trend research prepared by Stamford, Connecticut-based VantageScore Solutions LLC, has discovered.

So in other words, a borrower who had a 600 credit score in 2005 does not represent the same amount of default risk as a borrower with a 600 credit score in 2010.

VantageScore found, in fact, that lenders building their strategy around a 4.5 percent default level in 2005 would have set their credit-score cutoff at 600. But in 2010, that same credit-score cutoff would have resulted in an 8.5 percent default scenario. In 2010, to keep defaults in the 4.5 percent range, the credit-score cutoff actually would have to be raised to 660.

VantageScore offered another example in a research presentation titled "Risk Shift Trends." If a lender wanted to follow a 4.25 percent default strategy in 2005, it would have had to set a cutoff for credit scores of 600. In 2009, that same cutoff for credit scores would have resulted in an 8.1 percent default scenario. To maintain the 4.25 percent default level, it would have had to move the credit-score cutoff to 660.

VantageScore's research found that there was a nearly 90 percent increase in default risk between 2005 levels and 2009 levels. Credit-score cutoffs being followed in the marketplace were too slow to catch up to the growing level of default risk.

The research also suggests that today's credit-score cutoffs are too high for the current level of actual market default risk. VantageScore has found that default levels have dropped from their peak in 2009--with 2013 levels virtually returning to 2005 levels.

So while market participants may look at a 620 credit score as inherently and excessively risky, it all depends on conditions in the larger housing marketplace at the time. In 2014, it may be time to revisit expectations about the 620 credit-score borrower--and shed some preconceived notions in favor of better data.
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Title Annotation:NEWS ROOM
Comment:Credit-score cutoffs need recalibration to reflect current default risk.(NEWS ROOM)
Publication:Mortgage Banking
Date:Apr 1, 2014
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