Strategic Default and the FICO or VantageScore


Strategic default is a conscious decision to walk away from a mortgage that is underwater. These defaults take lenders by surprise as borrowers often have excellent credit records and meet all of their other financial obligations. The point of a strategic default is to cut losses on a home that has substantially depreciated in value and negative equity that can never be recovered.

Considered as a viable strategy for managing troubled assets in an era of record foreclosures, high unemployment, and government bail-outs, millions of Americans are considering strategic default or strategic foreclosure. With almost 28 percent of all mortgages underwater, a growing number of homeowners are contemplating this strategy.

While borrowers are contemplating strategic default, lenders are seeking predictive indicators to prevent them through advanced credit scoring technologies.

A dynamic number reflecting an individual’s ability to repay, credit scores are assigned by companies like Fair Issac or VantageScore. They play a critical role in determining where an individual is eligible for a loan, the loan amount, interest rates and repayment terms.

Fair Isaac, creator of the widely-used FICO score, recently introduced an enhanced version of its popular scoring model, the FICO 8 Mortgage Score. This model will make it tougher for most consumers to secure mortgage loans.

Offered as a credit rating product directly by the Equifax, Experian and Trans Union consumer reporting agencies, and not nearly as popular, the VantageScore is also undergoing significant changes.

Both credit-scoring models have been enhanced to better anticipate consumer behavior amid a foreclosure crisis and tough economic times. Specifically, they have fine-tuned their predictive powers to assist lenders in determining which borrowers are likely to strategically default.

According to a recent Experian-Oliver Wyman Market Intelligence Report, strategic defaults rose 53 percent in the first half of 2009, to 355,000 foreclosures. Previous studies found that 588,000 strategic defaults occurred in 2008, double the level that took place in 2007.

“Many borrowers are being advised to stop paying their mortgages,” says Carlos Reyes, a foreclosure defense attorney with the Reyes Law Group in Fort Lauderdale. “Making the decision to simply walk away is bad for the homeowner. Borrowers should consider their rights and contemplate the long ranging consequences of such an action.”

While the details of FICO and VantageScore credit scoring models are proprietary, some facets of each are known.

Fair Issac introduced the FICO 8 Mortgage Score in October 2010. VantageScore 2.0 will be introduced next month.

Claiming to save in excess of $1 billion by helping to prevent 115,000 foreclosures, FICO officials indicate their new model is 15% to 25% more accurate in predicting strategic defaults than its predecessor.

“The FICO 8 Mortgage Score’s broad availability means that all U.S. lenders and servicers can now easily access scores that are fine-tuned for mortgage performance,” said Jordan Graham, executive VP of Scores and president of Consumer Services at FICO. “Moreover, by combining this superior predictive performance with the FICO Economic Impact Service, lenders are able to adjust policies and strategies quickly based upon forward-looking economic modeling. This is what we mean by the FICO analytic advantage: the ability to use the most advanced predictive analytics to compete and win in this highly challenging environment.”

When the VantageScore debuted in 2006, it was based on an analysis of 21 million credit files over a two-year period. To devise its new scoring model, dubbed VantageScore 2.0, the company examined a larger set of credit data over a longer period of time.

VantageScore 2.0 is based upon an analysis of 45 million active credit reports. Those reports came from 15 million anonymous consumers whose credit histories were examined across the Equifax, Experian and Trans Union consumer reporting agencies. VantageScore’s updated scoring system also covers overlapping three-year time periods from 2006 to 2008 and 2007 to 2009 to account before and after the recession.

As a result, the improved VantageScore 2.0 has been dubbed a “recession-era credit scoring model.”

“We’ve recently experienced a variety of economic scenarios, including an increase in foreclosures in the housing market and changing payment hierarchy among consumers,” said Barrett Burns, President and CEO of VantageScore Solutions. “Building VantageScore 2.0 using a blend of consumer behaviors from 2006-2009 produces greater score stability over time.”

For consumers, what is most important about the improved VantageScore is that it places more emphasis on certain areas of your credit behavior, and less emphasis on others.

The single biggest change with VantageScore 2.0 is that shopping for credit or opening new accounts could impact more than it had previously. Under VantageScore 2.0, recent credit activities, such as submitting new credit applications, now account for 30% of the score. Under VantageScore 1.0, inquiries and recent credit activities comprised just 10% of the score.

Likewise, account balances and length of credit history are of less significance under VantageScore 2.0. They now account for 9% and 8%, while under VantageScore 1.0, they accounted for 15% and 13% of the score.

FICO scores range from 300 to 850 points. The VantageScore ranges from 501 to 990 points. Even though I manage credit wisely, I was recently surprised to learn that my FICO score from Equifax was 837 while my VantageScore was an almost perfect at 988.

Source:  The Credit Report with Bill Lewis – Highlands Today, an edition of the Tampa Tribune – Media General Group. http://www2.highlandstoday.com/content/2010/dec/05/strategic-default-and-the-fico-or-vantagescore/

To review Bill Lewis’ entire consumer protection series at the Highlands Today, visit www.williamlewis.us.

William E. Lewis Jr. is a credit repair expert with Credit Restoration Consultants and host of “The Credit Report with Bill Lewis” on AM 1470 WWNN, a daily forum for business and financial news, politics, economic trends, and cutting edge issues.

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