| LOS ANGELES
LOS ANGELES May 10 The crisis that has swept the U.S. subprime mortgage industry may come down to a simple, three-digit number, multiplied by millions.
Lenders in the midst of an unprecedented U.S. housing boom pared borrowing requirements to a minimum -- a single number, known as a "FICO score," that was supposed to reflect the borrower's ability to repay a mortgage.
Traditional down-payment demands were dropped. Borrowers were taken at their word because checking a salary took too long. Proof of savings, housing history, a job -- sometimes these, too, fell by the wayside.
Critics of the system argue scores are full of errors and dangerous to use alone. They also are easy to manipulate. A cottage industry has thrived helping prospective borrowers raise their scores without changing their underlying ability to repay a mortgage.
"There are fundamental flaws in the system because people can manipulate characteristics to get the FICO score they would like to see," said Kevin Jackson, a strategist who follows mortgages at RBC Capital Markets in New York. The system can be played "to come up with the kind of mortgage for people who really couldn't afford a house."
A credit score and a written, unchecked statement of income have often been enough to get a loan. That provided the fuel that kept the housing boom going as huge demand for homes met a seemingly endless and unchecked supply of money.
"The combination killed the goose," said Bill Dallas, chief executive of Ownit Mortgage Solutions, a failed subprime lender headquartered in Agoura Hills, California. Subprimes are higher interest rate loans for lower-credit-quality individuals.
Mortgage failures hit record highs at the end of last year and the housing industry is in crisis. Now, loans worth hundreds of billions of dollars could be in jeopardy.
TRICKS OF THE TRADE
The FICO scoring system takes its name from Minneapolis-based Fair Isaac Corp., the company that developed it in 1989. FICO scores have been used by credit-card companies, auto loan providers and mortgage lenders as part of a process to grant credit for billions in purchases. FICOs incorporate five types of information to calculate a score on a scale of 300 to 850.
A score above 700 is strong, mid-600s is good for many, and 620 is clearly considered second-tier, or subprime.
FICO has been embraced by the $10 trillion U.S. mortgage industry as an objective, easy-to-use way to make the market more efficient and fair, and even after the demise of some two dozen lenders, it is the main lending criterion for many companies.
"Now the banks don't want to hear letters of explanation. They just want to learn FICO scores," said broker Bob Moulton, president of Americana Mortgage Co. in Manhasset, New York.
Lenders who focused too narrowly on FICO numbers often failed to see how the figure was being misused.
"You can do a lot more than you should be able to do to a FICO score, a lot quicker," said Ownit Mortgage's Dallas, a real estate industry veteran. He said a FICO score can predict default but his company used scores as just one element in a complex set of factors used to approve loans.
One problem with relying exclusively on credit scores is they are easily changed. Consultants are available to fix errors in credit reports and also offer tips to raise scores, undermining the system.
For example, borrowing money to temporarily pay down debt can boost the score. Ironically, opening more credit card accounts can also increase their amount of available credit -- and sometimes can boost the score.
Another common way to boost scores is to piggyback on a relative's good standing by getting added as an authorized user of their credit cards. That way, it appears the person has the same access to credit as the relative.
Entrepreneurs are taking that idea a step further, making a business of buying and selling credit card accounts, or "tradelines." For $1,500, addatradeline.com offers to connect a customer to another person's credit card with a $15,000 limit and 10 years of payment history, creating the appearance of a solid borrower.
"As long as there are banks out there that will score with tradelines, there will be a market for this," said Adam Wheeler, owner of the Orange County, Calif.-based addatradeline.com.
Lenders bragged that credit scores were rising among borrowers in the midst of the housing boom. However, a rising level of delinquencies last year revealed growing problems with the system. The total of loan payments more than 60 days late by January had surged to record highs above 14 percent, up from near 6 percent in mid-2005, according to UBS Securities data.
As more people joined the real estate industry, lenders won business with offers of more flexible loans, lower rates and faster turnarounds. Paperwork became the enemy of speed.
Credit histories, part of the basis of a credit score, require some judgment and training to interpret, and decisions are subjective.
Armed with FICOs, lenders gave questionable borrowers leeway, such as requiring less proof from self-employed professionals with no steady job or pay stub. The strong housing market, combined with the ability to resell almost any loan to investors, lulled lenders into a sense of complacency.
Three large credit reporting companies -- Equifax, Experian and TransUnion -- produce FICO scores based on their own refinements of the basic Fair Isaac system.
BIG INCENTIVE FOR SMALL CHANGES
Credit scores make a big difference and even small changes can mean real savings to consumers or much higher fees to lenders.
A $200,000 30-year fixed rate loan in California would cost a borrower with a 760 FICO $1,182 per month, or $364 less on each payment than for a borrower with a score below 620, according to myFICO.com, Fair Isaac's consumer-oriented Web site.
Boosting scores has become a booming industry. Deborah Vasile, a Cape Coral, Florida, mortgage processor who went through a recent business bankruptcy, said her credit score rose more than 100 points after she paid about $500 to Credit Repair Today of Tampa, Florida.
Considering buying a new car and a home, Vasile said she heard the service could remove bankruptcies from records before the typical seven-year posting period expires. After several derogatory items were consolidated into a single strike against her, she's now house hunting.
Elizabeth Warren, a professor at Harvard Law School, said she questions how an entire industry can be based on claims of quick fixes for a person's creditworthiness.
"If credit repair can help someone alter a FICO score for people that can pay a fee, doesn't that say that a FICO score is not a very reliable indication of a person's financial status?" she said.
HIGHER FICO, LOWER PAYMENT
As the credit-scoring system grew larger, it became more prone to errors, critics say. Credit reporting companies process some 4.5 billion pieces of data every month, and some 79 percent of consumer credit reports contain errors, according to a 2004 report by the Federation of State Public Interest Research Groups.
Congress in 1970 required that companies verify and correct incorrect information within 30 days, opening the door for a new industry of credit repair services that often hound credit bureaus to get information expunged.
The credit rating companies question the tactics used by the credit repair firms that pressure them to change credit histories.
Deborah Vasile said her credit repair service is on a fourth round of challenges on her behalf, attempting to remove the bankruptcy from her record.
Carl Jensen, owner of Credit Repair Today, said his service pushes for deletion of "derogatory items" as allowed by consumer law.
"Sometimes it's that repetition; it's just beating them down," Jensen said.
Credit-repair companies have attracted plenty of criticism themselves, and shady businesses pop up all the time since there's little barrier to entry, Jensen said.
Credit bureaus are also beginning to rule that signing up as an authorized user on someone else's credit account is not a legitimate practice, said Helayne Urban, a personal credit consultant in White Plains, New York. Experian no longer accepts such tradelines in its scoring, she said.
Meanwhile, mortgage brokers, which launch some three-quarters of all subprime home loans, are finding new ways to boost scores in a short period of time.
Ellie Mae, a private company that is the biggest provider of loan origination software for the country's 40,000 mortgage broker companies, plans to unveil the "Maximizer," a program that for $25 spits out steps a customer can take to improve a credit score to a level that meets a lender's guidelines.
In recent months, mortgage brokers have been clamoring for such tools as they struggle with tougher lending standards and a falling number of mortgages, said Mitch Freifeld, president of Branch Management Solutions in Clearwater, Florida.
Mortgage originations will likely fall by 20 percent over three years to $2.247 trillion in 2009, according to the Mortgage Bankers Association, an industry group.
SCORES LESS RELEVANT
Ideally, consumers would use suggestions from the Maximizer and credit consultants to improve their credit standing, and the higher scores would lead to more favorable loans. But Fitch Ratings suggests higher scores have become less relevant in predicting who will quit making payments.
As evidence, they point out that the average FICO score on loans that defaulted within their first year was 615 last year, just 10 points less than on loans with current payments. The gap was a better indicator in 2003, when bad loans were scoring more than 30 points less than good ones, it said.
In 2005, CreditSights, an independent credit research firm, said FICO scores have become an excuse to lead consumers into higher levels of indebtedness. Banks responded by displaying rising FICO scores as a panacea to calm concerns about future credit deterioration, the analysts said.
The companies that issue the scores defend their products and say consumers only hurt themselves by omitting valid credit information.
"It just means the consumer has an inflated credit-risk potential and may end up getting a loan they should not have had in the first place," said Stuart Pratt, president of the Consumer Data Industry Association in Washington, whose members include Fair Isaac and the three main credit reporters.
Fair Isaac Chief Executive Mark Greene staunchly defends his system, but facing what he called an "emerging sense of hysteria" in March, he asked a deputy to remind lenders to use all available information in their loan decision-making.
Some lenders may have lost faith in the system. In response to lenders' demands, Equifax, Experian and TransUnion together developed a more predictive credit score model, according to Barrett Burns, who is chief executive of VantageScore Solutions, the collaborative effort to weed out inconsistencies between the companies.
Lenders today might take a lesson from failed underwriters that may have ignored the details at their own peril.
Executives from mortgage lender New Century Financial Corp. cited FICO scores to demonstrate the quality of their mortgage loan portfolio. On May 4, 2006, for example, New Century told investors and analysts its average FICO score was 633 at the end of the first quarter of 2006, up from 600 in 2003.
"Credit performance is better than historical experience and has exceeded our expectations," the company's slide presentation said.
Eleven months later, New Century filed for bankruptcy protection.