The Cogent Road

While it’s newsworthy to note that mortgage foreclosures are hitting all time record numbers – the fact itself is nothing new. What is new is that additional foreclosures, above and beyond what banks are predicting, will likely exasperate the situation. The reason is that every mortgage loan portfolio contains an as yet undetected ticking time bomb, a risk factor so significant that two percent of loans could have additional foreclosure risk. Ironically, this risk was never even considered when deciding to fund the mortgage loan in the first place.

The risk I’m referring to is the so called Authorized User account, a ridiculous legacy based credit reporting methodology that allows a borrower’s credit score to be calculated using someone else’s payment history. Saying it another way, a bank grants a mortgage to a borrower whose credit report contains the tradelines and payment records of other people. While this would seem incredulous, its common mortgage lending practice.

Authorized user accounts occur when a credit card account holder asks for a credit card to give to someone else. This practice makes sense as its quite common for one to give their spouse or child a card. But what doesn’t make sense is the way in which these new cards (called “authorized user” accounts) are reported by the credit bureaus.

To illustrate this lunacy further, let me share an actual example.  I’ve had an American Express card since 1990, I charge a good amount on it every month and have always paid on time. My credit report reflects this account, which seasoning and payment record boost my credit score. Years after I opened this account I got married and requested an American Express card for my wife. Although she has no income and does not pay for this credit account, her credit file now contains a tradeline that reflects a credit card opened since 1990 with excellent payment history; basically an exact copy of my credit history with American Express shows up on her credit report. And her credit score gets the same exact boost as mine does – even though she is not the one responsible for this card.

Maybe your initial response is that it doesn’t matter because she is my wife, or that it’s not a big deal because if we apply for a mortgage loan we’re looked at as a couple. Well, you’re not alone in your thinking because when I’ve discussed this with banks they express the same idea. But the logic is fatally flawed and these authorized user accounts create a very big problem. Allow me one more example – this one fictitious, yet illustrative nonetheless.

Let’s assume my wife and I are applying jointly for a mortgage loan. Let’s also assume my wife is the authorized user on several of my accounts, each with a good payment history. However, in this example let’s also assume I have some derogatory accounts, maybe even a bankruptcy. Now the bank, knowing we are applying jointly, decide to approve the mortgage based my wife’s good credit. (This too is common mortgage lending practice). However, what has the bank actually done? Since my wife’s credit is based on authorized user accounts she actually has no real credit of her own – but what she does have is a “subset” of my credit – just the good stuff. What really happened is the bank gave a go decision based entirely on my few good tradelines, while completely disregarding all the derogatory history. It’s unlikely the bank would have made this loan if they understood how the authorized user accounts were masking true credit risk.

Cogent Road has spent the past year researching this phenomenon – and I’ll share some rather alarming data points.

1. More than 3 out of 10 people  have authorized user accounts in the credit files
2. 2 out of 100 people have a credit score raised by more than 10% because of someone else’s credit. This means that someone whose actual credit history should reflect a 648 credit score, would instead produce a 720 score for lenders.
3. Most shocking of all: 1 out of 200 people actually would have no score if you discard the authorized user accounts. In these cases banks are approving mortgage loans for people with absolutely no credit history at all.

Today’s mortgage portfolios must be screened to asses which loans were approved based on credit scores elevated by authorized user accounts. These loans should then be routed to a call center that can regularly monitor the borrower’s ability to pay during this foreclosure crisis. More importantly, every new loan should be screened to detect how much influence authorized user accounts have on the credit score. Depending on the results, some applications (regardless of a high credit score) should be declined altogether – while others would be sidelined for review prior to approval.

The good news is that new technologies can help banks do this immediately.