Fannie's New Rental History Credit Boost Not as Simple as it Sounds

It seemed like a simple solution for expanding the credit profile of many first-time homebuyers, but Fannie Mae's new plan to utilize rent payment history to that end will not immediately remedy the situation. Linda Goodman and Jun Zhu, in a new post on the Urban Institute's (UI's) Urban Wire blog, say it will eventually prove beneficial to many borrowers.

The two write that rental payment history is a strong predictor of borrower performance on a mortgage and Fannie Mae estimates its new process will allow about 17 percent of first-time borrowers, who are initially turned down for a loan, could be approved if they have a clean 12-month rental payment history. However, they say not all originators will be prepared to offer borrowers this option on its September 18 launch date.

Here, as Goodman and Zhu describe it, is how the process will work. Lenders will submit a mortgage application through Fannie Mae's Desktop Underwriter (DU) as they do now. If the DU finds the loan is ineligible for purchase, it will check for all first-time homebuyers if a clean rental payment history might change the outcome. If so, the lender will be notified and can ask the borrower for permission to access their bank statements.

Here is where it gets more complicated than it first appeared. Lenders cannot request the bank statements directly because this data is highly confidential, and banks are willing to release it to only a limited number of vendors that meet their criteria for protecting it. Thus, UI says, the new program will take a while to become fully operational because few mortgage originators use those vendors.

Once borrower permission is obtained, the lender will order a report from an approved vender who will verify the permission with the borrower via a text or email then access the data, forward it to the lender and the DU which will automatically check the existence of a rental history. If it is consistent with the rental payment amounts on the initial application the loan will be deemed eligible for sale to Fannie Mae.

Fannie Mae expects a relatively small number of new mortgage approvals as this new system goes online, but over time the system should expand to allow for more vendors, and for originators to gravitate toward vendors with appropriate capabilities.

Complications aside, the authors said they recently refreshed a UI study from 2018 which found that housing payment history (as a proxy for rent payments) predicts mortgage performance significantly better than credit scores, which rely heavily on credit card and other debt payments.

UI looked at 2016, 2017, and 2018 data on first-time homebuyers with active Fannie Mae mortgages in each of those years, classifying them by number of missed payments. Each set was then tracked for past due payments of 60 days or more over the following two years. The last year of the study included loan performance during the COVID-19 pandemic.

The authors say borrowers with no missed payments at the baseline performed well over the following two years, regardless of FICO scores. Those with a single missed payment fared considerably worse. For example, only 4.0 percent of first-time homebuyers with FICO scores below 700 and no missed payments in 2016 went 60 or more days delinquent in 2017 or 2018, versus 28.4 percent of borrowers who missed one payment in the same FICO score bucket and 11.7 percent of borrowers with FICO scores above 750 who missed one payment.  

While the subsequent performance of the 2018 outstanding payments in 2019 and 2020 is worse than in the earlier years, presumably because of the pandemic, the original conclusions hold true; the results demonstrate that the performance of the mortgage payment history is the best predictor of future defaults. UI says this should apply to rental as well as mortgage payments. UI's earlier study showed that, for most income groups, monthly gross rents are comparable with monthly costs for homeownership.

The authors conclude that Fannie Mae's incorporation of rental payment history into the mortgage application process will open the doors to homeownership for many buyers who have been locked out. But further, this change will likely inspire future innovations in mortgage lending that could eventually unlock the door to tens of thousands of otherwise qualified borrowers to become homeowners.