I have a friend named Dormand Long. We met at my house, when he brought his son to a Dartmouth College send-off party, which we usually host. Dormand is brilliant. Not sure what he does for a living, but is a research genius and sends a plethora of information my way. There are honestly not enough hours in the day to blog all I find, and I would love to know how Dormand manages to dig up and devour all he does. Now, he’s onto credit bureau ratings.
Do you know how hard it is to get a mortgage these days? You have to have a near perfect credit score — that means a scoreboard-high FICO score — and you have to have a rock solid job. Self-employed and not taking home a salary? Fat chance of getting a mortgage, bud. Credit has tightened like a noose these last few years and we all know why — banks were lending sloppily, making quick bucks off each transaction and giving less than a damn about where the loan went next. Well, the after-party from all that is what we are living with today — the tightest credit market EVER.
So what if someone — in this case, Dormand — found out that the mega credit bureau Experian has systematically screwed Texans by misclassifying real estate loans as installment loans? That’s what he says: Experian bundles real estate loans as consumer credit loans when they should not. The algorithym is flawed — and I have to admit I still don’t understand algorithyms, so not sure what this flaw would be. Loans against your real estate are not in the same category or bathtub as consumer credit. They are “better loans”, and they are back by an asset. Consumer credit loans are more frivolous — like my clothes, or a new TV or vacation to check out vacation homes. Call in the consumer credit and there is no asset behind it. So why is Experian lumping together real estate-backed loans with consumer credit loans? Good question. I hope we can find out. As for Dormand, he’s written the Texas attorney general Greg Abbot and the New York Times and we will see what happens. Here’s his letter:
August 25, 2011
Attorney General of Texas
The Honorable Greg Abbott
Re: detriment to citizens having Texas home equity loans caused by a systemic flaw in an algorithm used by credit bureau Experian.
There is a significant impairment in future loan accessibility of those who have taken out Texas Home Equity Loans to educate their children or to improve their homes.
This flaw appears to be systemic and the current format for the credit report provided to the consumer has virtually no discernable clue to the fact that the Experian algorithm classifies 30 year, closed in, fixed rate, amortizing, having federal-income-tax-deductible interest Texas Home Equity Loans, not as real estate loans, but instead as the credit-damaging- excessive installment loans.
To state the obvious, installment loans reflect spending on credit on consumer durable goods. These goods typically depreciate in value quickly and have little value left after five years. To reflect this projected immediate and almost total value loss, financing is not only normally limited to five years or less, it is made through add-on interest, and is subject to the notorious Rule of 76. Those who fritter away their earnings by excessive spending on cars, boats, motorcycles, appliances, furniture, hot tubs, big screen televisions, and entertainment systems tend to have excessive balances of installment loans.
There is little lasting resale value to the consumption goods purchased through this sort of credit. Thus lenders limit approvals on new credit accommodations to applicants having acceptable and conservative ratios of installment loans to gross household income.
As the normal financing of these consumption goods is for five years or less, servicing of debt would appear to be unsustainable if this ratio were high. Most lenders are not comfortable with ratios of installment loans to gross household income which are greater than 20 to 50%.
On the other hand, most financial authorities consider the purchase of a personal residence to be the cornerstone of building solid and lasting financial stability. Lenders tend to be comfortable with ratios of real estate loans to gross family income of 200%.
Real estate loans are considered as a pillar of stability for a family due to:
a ) the loans being amortizing, not add-on,
b ) the underlying asset should hold its value, and in many cases, appreciate in value, if properly maintained,
c ) the underlying asset provides shelter to the family, eliminating the need for separate and expensive payments of rent each and every month,
d ) interest on the loan is deductible in computing itemized deductions for federal income taxes,
e ) the owning of a personal residence suggests that the family not only will have less of a propensity to move, but has made some commitment to the community,
f ) as the underlying asset is not expected to depreciate appreciably, loan terms are available for far longer terms, with 30 loan amortizations being common.
Thus, by virtually all comparison factors, lenders are far more comfortable seeing indebtedness in the investment-oriented real estate loan category than in the consumption-oriented installment loan category.
Apparently credit bureau Experian has chosen to make public policy via its systemically flawed algorithm which treats closed-in Texas home equity loans, not as in the logical real estate loan category, but instead in the illogical installment loan category.
Thus, Experian’s flawed treatment of 30 year home equity loans signals to lenders that this consumer has no investment-building, shelter-providing, and value-retaining long lasting asset such as a personal residence, which warrants 30 year loan terms, to justify indebtedness.
Instead, the flawed Experian treatment of home equity loans as installment debt signals that the consumer has frittered away his earnings in buying consumption goods with no lasting values. As installment loans typically must be paid off in five years or less, that implies to a lender that the annual debt service on the installment loans subtotal will be 20% of the outstanding balance.
If the installment loans subtotal is large in comparison to gross household income, this suggests some doubt as to the consumer’s ability to pay all his debts on a timely basis.
As detrimental to the family’s future access to the prime sources of low cost capital being constrained by this flaw in the Experian algorithm is, what is absolutely deplorable is the fact that there is absolutely no disclosure to the family taking out the Texas home equity loan that their future access to capital will be materially impaired due to the ramifications of this flawed reporting.
If the agony one goes through in seeking the most prime and lowest cost capital accommodations appropriate to an impeccable payment history and very stable employment and residence records were disclosed in advance to those seeking a loan, I suggest that 80 percent of those seeking capital would avoid a 30 year Texas home equity loan.
When one examines the cascading effects of this flawed practice, one sees the undermining of our social fabric. Those who take out a Texas home equity loan to pay tuition for children may find that their impaired access to capital in the future may well cause them to have their child drop out of school later.
Separately, there are many cases in which a family needs a larger home to accommodate a family size which has outgrown its current home. The media report that there are many instances in which a buyer has a ) ample cash for a down payment, b ) stable job and residence history, c ) ample discretionary income to service home loan payments, and d ) an impeccable payment history.
Yet, far too many families with such a solid profile are turned down for the purchase of a larger home, simply because their credit scores are too low.
If the root cause of their artificially and incorrectly lowered credit scoreis the flawed algorithm on Texas home equity loans at Experian, then we have a definite detriment to society. This calls for regulatory action and relief to those oppressed homeowners who took out those 30 year home equity loans in good faith, and in certainty that each and every valid debt incurred by them would be paid on time and in full.
Furthermore, assuming that the information in credit bureau reports has some validity, many lenders assign different pricing to credit tiers of loans. The aggregate differential in interest rates and thus monthly payments over the life of a 30 year mortgage can be an enormous sum of money, enough to make the difference between a comfortable retirement and a retirement with a hand-to-mouth existence. Car loans are similarly put in tiers ranked by credit score.
This systemic flaw in the algorithm at credit bureau Experian creates a perpetuation of the underclass when these scores place hardworking, honest, and prompt paying borrowers into a lower loan quality tier.
In addition, many companies are using credit reports as a vetting tool for choosing candidates for responsible positions. If one who has the misfortune to have taken out a Texas home equity loan to pay tuition for his daughter’s education is the most qualified of a group of three finalists for a highly responsible job, he may well lose out due to the erroneous and flawed information on the Experian credit report. This signals to the credit bureau report reader that this candidate has wildly inappropriate spending habits, as the installment loans outstanding far exceed gross household income.
These credit bureau reports on Texas home equity loan users are a farce. They falsely undermine the access to capital and to the job market. This flaw with Experian credit reporting creates a pox upon society. It should be dealt with immediately upon the conclusion of due diligence of all available credible evidence.
I recommend action via the following avenues of relief:
a ) exposing the flaw in the reporting of 30 and 15 year closed in Texas home equity loans,
b ) requiring immediate and full disclosure to loan applicants as well as Texas families with home equity loans that this flaw will significantly impair their access to credit in the future until the home equity loan is retired,
c ) requiring that the credit bureau add vital information of the debt category subtotals and total indebtedness, and
d ) mandating that credit bureaus report 30 and 15 year closed-in home equity loans only as real estate loans.
Please note that prior to obtaining critical information on this systemic flaw, I had filed a complaint which your department assigned as case # D377588 401.
I have for review by your delegate documentary evidence of the misclassification of indebtedness by credit bureau Experian that will be made available immediately by your Department’s request.
Your attention to this matter, which has caused substantial harm to innocent citizens of The State of Texas having meticulous bill paying habits by denying them their rightful access to capital, as well as access to the best jobs, would be appreciated.