June 27, 2011
Historically, mortgage defaults have been the result of catastrophic financial distress. Conventional wisdom assumed homeowners would forgo paying all other debts, hold the mortgage payment sacrosanct and keep it as their first priority. However, research conducted by TransUnion, a national credit reporting agency, has shown that a growing number of consumers continue paying other debts, such as bankcards and auto loans, as they let the mortgage default. Whether today’s homeowners allow the mortgage to default due to an inability to pay, anger, fear, or an investment decision, there are now a great number of consumers with foreclosures in their credit files.
A percentage of the consumers with a foreclosure on their credit files has no other delinquency present. When these consumers subsequently apply for new loans, credit unions may likely take some course of adverse action, such as increased pricing, less favorable terms or denial. These actions are made pursuant to the reasoning that previous derogatory credit is a primary indicator of future derogatory credit performance.
But the TransUnion study indicates that this approach may no longer makes sense in all cases. While credit scores remain the best predictors of risk, external factors influencing consumers, such as unemployment and home value depreciation, show they might perform differently than one would expect. The TransUnion research shows that consumers might be more likely to pay other debts rather than real estate secured debts, particularly in certain states where real estate prices dropped dramatically. If the consumers are more likely to pay other debts, should they be considered for new non-real estate secured loans?
This brings about a potential opportunity for credit unions that are willing to extend credit to these consumers. Pockets of opportunities outside of the highly targeted prime segment can be found in foreclosure populations – potentially profitable, loyalty-building, low competition prospects.
In particular, the TransUnion study revealed that consumers who defaulted only on their mortgage loans during the recession were far better risks than those who had a foreclosure and other contemporaneous delinquency. Mortgage-only defaulters, regardless of their credit scores, showed consistently better performance on auto loans, credit cards and other personal loans.
The TransUnion study split consumers with foreclosures into two groups: those who defaulted only on their mortgages, and those who defaulted on their mortgages and other accounts. The performance of new loans opened by these consumers was evaluated for 12 to 17 months. The data show that there is a significant difference in subsequent loan performance between the groups:
Now, a common argument for the good performance of mortgage-only defaulters on other loans is the “excess liquidity theory,” the idea that consumers will more consistently repay non-mortgage obligations during the foreclosure process due to the increase in available cash when they stopped paying their mortgages. According to this theory, consumer performance on accounts opened later in the foreclosure process should demonstrate worse delinquency over a fixed performance window than those opened earlier in the foreclosure process. Interestingly, TransUnion could find no evidence to support this theory; in fact, the study found that consumers in the foreclosure process performed similarly, if not better, on certain accounts when they opened them further in the foreclosure process. Likewise, delinquency rates on other accounts did not increase with the passage of time since the foreclosure, which indicates that these consumers continued to make timely payments on their other accounts even after returning to the housing market through rental or otherwise.
Historically, lenders have deployed scoring systems along with sound credit policy rules in their decisioning processes. Some credit unions, for example, had strict policy exclusions, such as presence of a bankruptcy found on the credit bureau file. Over time, many credit unions have evolved to make exceptions to such strict policies by deploying additional data screens and analytic tools to identify “acceptable,” credit-worthy customers with a prior bankruptcy on their file.
Additional research into these groups would likely identify similar protocols enabling credit unions to better quantify the risk of a member or prospect with a previous foreclosure but a strong likelihood to repay other credit obligations. The findings of this initial study by TransUnion on mortgage defaulters suggest a careful segmentation of certain mortgage defaulters may yield a new credit-worthy segment for credit unions to explore.
Credit unions and their members are experiencing very difficult economic circumstances. By evaluating new loan applications with analytically-derived pricing and loss expectations, credit unions have opportunities to establish new relationships with members or prospects who are now returning to credit activity. To learn more, please visit TransUnion's credit union-specific web site.Art Kics is a senior manager in TransUnion’s analytics and decision services business unit. David Dodson is a vice president in TransUnion’s financial services business unit and can be reached at firstname.lastname@example.org.
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