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  • 05/09/2002
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The role of credit scoring and underwriting in the mortgage application process

What is the difference between credit scoring and underwriting?

Credit scoring is a system used by some lenders to streamline the lending process. Applicants are screened, using a questionnaire or scorecard to determine their suitability as borrowers. The questions are designed to ‘screen in’ the type of applicants that have proved to be a good credit risk in the past. The individual scores are calculated using a formula unique to each lender.

Underwriting, on the other hand, is the more traditional approach to lending, where each application is scrutinised by an experienced underwriter responsible for making the lending decision.

Which lenders use credit scoring and which use underwriting?

In general, high street lenders that deal with standard, prime, full-status applications will use credit scoring as a quick and effective method of processing a high volume of applications. At the other end of the scale, niche lenders and those that offer non-conforming and sub-prime loans will tend to use underwriting, as this method enables cases to be assessed on their individual merits and allows additional information about the borrower’s circumstances to be brought into consideration.

Why don’t all lenders use underwriting?

For high volume, mainstream lenders use automated credit scoring that allows bulk processing of applications quickly. This is an advantage both to lenders and their borrowers who, in general, have good credit histories and stable lifestyles. Employing expensive underwriters to simply rubber stamp standard applications would be a waste of money and resources. The more specialised lenders tend to stick to underwriting as it enables them to give applications the individual attention they need.

Are some borrowers more suitable for the credit-scoring system than others?

People with full-status proof of earnings, stable jobs and lifestyles, a good history of meeting payments and no history of adverse credit are most suitable for the credit-scoring method. Those applicants with income from many sources, no track record of making regular payments, gaps in their work/residential record, or a past history of credit difficulties would be more suitable for underwriting, as this method gives the opportunity for explanations to be submitted and taken into consideration.

How do lenders determine what factors to include in their credit score?

Each credit-scoring system is unique to the lender that is operating it. Credit scoring is based on the notion there is an ‘ideal’ borrowerš for each lender and each applicant is matched against that ideal.

The factors that make up a lender’s credit-scoring system will depend on the data built up by that particular lender on the types of borrowers who have proved to be good credit risks in the past. For example, if married couples have proved to be better credit risks than co-habitees, this question will be included. Likewise, if those who have moved home frequently in the past few years have proved to be worse credit risks than those who have lived only in one place, then this will also be part of the credit score. Even seemingly irrelevant facts ‘ like whether or not the applicant has a land-line telephone ‘ can be woven into credit score as a measure of stability.

What sort of factors will make it likely that a borrower will fail credit scoring?

It is not helpful to regard credit scoring in terms of pass or fail. It is not like a driving test where the individual knows they have failed on specific points. Credit scoring takes the answers to the questions it has asked and then calculates them according to a formula that weights the different subjects according to their importance and produces an overall score ‘ which either produces an offer or a decline. This situation often causes frustration for both the broker and the applicant, who are looking for specific reasons for being declined the loan and cannot understand why no such reason can be given.

However, if cases are individually underwritten, the underwriter can request additional information where necessary ‘ a process with a more human approach.

What part does the credit agency reference play in credit scoring and underwriting?

The core of both credit scoring and underwriting is the credit agency reference material. This is standardised data, but individual lenders choose the weighting they give to the various elements of the credit reference. Obviously if the credit reference information throws up a history of arrears or county court judgements (CCJs) for an applicant for a mainstream, prime product, then the application will be declined ‘ whether it is credit-scored or underwritten. However, moving into the niche and non-conforming markets, the question of arrears and CCJs, for example, is not so clear cut, and a hierarchy will be applied that ranges from minor adverse factors to major setbacks such as bankruptcy.

Secondary to the credit reference material (but still important) are the product criteria: minimum and maximum loan size; income multiples; minimum and maximum ages; the stipulated proofs of income, bank statements and so on. If these are outside the product criteria, then the application will also be declined or referred back for clarification.

Which system is better when it comes to recommending lenders to clients?

Each method is suitable for its own sector. Clearly, where the client’s circumstances are more complicated and need more explaining than a straightforward case, it is beneficial to recommend lenders who still recognise the human factor and underwrite applications.

On the other hand, credit scoring does allow for quick processing of bulk applications and that is why it is favoured by the mainstream lenders and is suitable for clients in that market.

Stuart Aitken is director of credit at Southern Pacific Mortgage Limited (SPML)

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