FICO Can Read Underwater Homeowners' Minds

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Thinking about walking away from your underwater mortgage? Beware: FICO is on to you. The credit analytics firm has developed a new methodology to catch potential strategic defaulters -- home owners who have the capacity to continue to make mortgage payments, but default because the home is now worth less than they owe -- before they quit paying. From what the company claims, the new capability sounds pretty impressive.

FICO doesn't need a creepy "precog" like those from the film Minority Report to figure out which underwater homeowners might strategically default. Instead, it uses statisticians. They have discovered key characteristics that predict which homeowners are more likely to willingly walking away from their home.

Stronger analytical techniques were needed to identify strategic defaulters, because borrowers whose homes lost the most value are only twice as likely to default as those whose houses lost the least value, according to FICO. In other words, just because a homeowner's mortgage is underwater doesn't necessarily mean strategic default is inevitable.

FICO has identified characteristics and behavior that sets off alarms for upcoming strategic defaults. How much better is the company's new analytical method? The riskiest set of borrowers that FICO can identify is 110 times more likely to strategically default than the group it identifies as least likely. That's pretty incredible.

What does a likely strategic defaulter look like? According to FICO, they are actually generally pretty savvy about their credit. This makes sense, since strategic default is, well, strategic. FICO lists the following as common characteristics of this group:

  • Better FICO Score (good previous credit history)
  • Lower utilization, less overlimit on credit card (better credit management)
  • Less retail balance (spend money carefully)
  • Shorter length of residence in property (less attachment)
  • More open credit in the past six months

Banks and servicers must be pretty excited to get their hands on this sort of predictive power. Why is this information so valuable? In many cases, banks can take preemptive action to prevent strategic default before it happens.

For example, let's say your home is worth $100,000 less than your mortgage balance. You know that walking away will ding your otherwise relatively strong credit record, but you determine it probably won't do $100,000 in damage. It makes sense for you to walk away. That is, unless the bank gets to you first to convince you otherwise. Perhaps it encourage you to do a short sale before you ever go delinquent on your mortgage. The bank will likely incur a smaller loss due to foreclosure-related costs it escapes. The borrower's credit score will be better off as well.

In fact, this analytical capability will help lower servicing cost in general, since it can isolate potential strategic defaulters more precisely. FICO says that the analytic can capture 67% of strategic defaulters in 20% of current accounts and 76% of strategic defaulters in 30% of accounts. In other words, banks could potentially reduce strategic defaults by 76% by only worrying about targeting 30% of their customers to market strategic default alternatives.

This new FICO product comes at a pretty key time as well. With real estate prices declining again in many areas, strategic default could rebound. When home prices rise, underwater homeowners might have more motivation to keep paying. But if home values in their area decline again, strategic default begins to look even more attractive. Through this new analytic, banks and servicers might be able to prevent many of those strategic defaults before they occur.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.
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