What Can Policymakers Do to Advance the Use of Rental Payment Data in Mortgage Underwriting?
One major barrier to persistent racial disparities in homeownership is inequitable access to credit. Black households are more than five times as likely as white households to be “unbanked,” meaning no one in the household has a checking or savings account at a bank or credit union, and are more than one and a half times as likely to be credit invisible or unscored. They also have lower credit scores on average, even when compared with white households at the same income level.
Lenders use credit histories and scores to gauge an applicant’s likelihood of repaying their loan—but this approach relies on inequitable metrics that are directly linked to systemic racism in the housing market. Historically, banks denied communities of color access to the safe financial services that allowed white people to build credit, leaving many people of color with no choice but to turn to riskier alternatives. Over time, the denial of equitable service has resulted in people of color being persistently less likely to satisfy the traditional credit requirements for a mortgage.
These persistent inequities have inspired recent efforts to include alternative data sources, such as rental payment history, in credit scoring and mortgage underwriting processes. Rental payments especially have been shown to be strong predictors of mortgage performance but traditionally are not considered in mortgage underwriting because the majority of rent payments are not reported to the credit bureaus and therefore not reflected in the credit scores.
In a recent report, we found evidence that including rental payment data in underwriting can make the mortgage application process more equitable, expand access to homeownership, and potentially reduce the persistent homeownership gap between Black and white households.
Incorporating rental payment data into mortgage underwriting has great potential, and both private companies and the federal government have begun taking steps to advance its use. But there is still more that needs to be done. Policymakers and regulators can consider four steps to improve data collection and standardization, clarify consumer protections in this space, and prioritize racial equity—all of which can advance the use of rental payment data and equitably expand access to mortgage credit.
1. Incentivizing rent reporting
There are two primary methods of improving alternative data collection:
- boosting rent reporting, in which consumers’ positive (on-time only) rental payments are reported to credit bureaus
- increasing use of consumer-permissioned data, which refers to data about payment histories that can be accessed through bank accounts
Currently, fewer than 5 percent of renter households (PDF) have their rental payment history on file with the three major credit reporting agencies, and these data largely come from missed, rather than on-time, payments. Evidence suggests better consumer education is needed, given that many are unaware that their rent payment is not included in their credit score (PDF) and do not understand the benefits of rent reporting (PDF).
Landlords are typically not incentivized to report their tenants’ rental payments because they experience a cost to rent reporting with little or no benefit to them. But regulators and policymakers can help change the incentive structure to encourage rent reporting. In the public housing space, national, state, and local housing agencies could pilot programs (PDF) that allow residents to report their on-time rental payments to the credit bureaus. At the federal level, both Fannie Mae and Freddie Mac have recently established programs that incentivize rent reporting for the owner-operators of multifamily properties they finance. In exchange for reporting on-time rental payments, they offer these owners closing cost credits on their loans.
2. Encouraging lenders to accept consumer-permissioned data
Compared with the lack of incentives for rent reporting, the primary barrier to increasing the use of consumer-permissioned data is lender uncertainty. The lack of data standardization contributes to this issue, with many complicating factors in using rental payment or other cash flow data. For instance, rent payments may vary month to month depending on whether utilities are included or whether multiple household members contribute to the rent each month, both of which make rental payment history more difficult to track.
Regulators have taken some steps to begin incentivizing lender use of consumer-permissioned data. As of last year, both Fannie Mae and Freddie Mac had begun allowing for the evaluation on-time rental payment histories in their mortgage underwriting processes if applicants fail to meet traditional credit standards. The Federal Housing Administration, which serves more borrowers of color, also recently updated its underwriting protocols to allow for the consideration of 12 months of on-time rental payments.
These are all significant steps to improving the use of alternative data in underwriting. But lenders still experience a degree of uncertainty around protocols for alternative data use. Updating regulatory guidance to clarify expectations would allow lenders to more comfortably extend mortgage financing to more households.
3. Clarifying consumer protections regarding alternative data use
It’s not just lenders who need more clarity on alternative data use to feel comfortable with broader adoption—the federal government should consider educating consumers and ensuring their rights in this space are clear. Of particular concern is that consumers, lacking clear guidance, could be harmed by the proliferation of alternative data if they are not fully informed as to which data are used and how.
Currently, one major source of uncertainty on this issue is how the Fair Credit Reporting Act (FCRA) applies to consumer-permissioned data transfers for underwriting purposes. The FCRA requires lenders to inform applicants which credit bureau provided the information that motivated their decision to deny a mortgage application or charge a higher price for a loan; consumers have the right to access and dispute this information.
Federal regulators have the power to clarify whether alternative data are considered consumer support and are therefore subject to FCRA requirements. In particular, the Consumer Financial Protection Bureau is currently engaged in rulemaking to implement Section 1033 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires financial services providers to make account data accessible to their consumers. Clear rulemaking in this area could clarify what data consumers have a right to access, as well as the data access and transfer standards for private companies.
4. Ensuring alternative data use advances racial equity with clear regulatory standards
It is vital that policymakers and regulators center racial equity in their approach as they develop regulations and guidance on the use of rental payment data. People of color have experienced persistent racism when interacting with the mortgage and credit systems, resulting in lower levels of trust and reduced willingness to engage with traditional financial services for many such households. Understanding and addressing this reality can help regulators move forward more equitably and inclusively.
To ensure the incorporation of rental payment data produces racially equitable results, regulators can employ pilot programs to work out any issues on a small scale. Pilot programs could be used to achieve the following:
- determine effective methods for increasing homebuyer awareness about the use and management of their cash flow data, particularly among households of color who have faced discrimination from landlords and who are wary of sharing access to their bank account information
- identify and address frictions that deter lenders from offering loans that rely on rental payment data
- understand the mortgage performance and risk associated with loans made using rental payment data
- test the effectiveness of more hands-on servicing for borrowers lacking traditional credit histories
Our research shows that equitably incorporating positive rental payment data into credit scores and mortgage underwriting could expand access to homeownership. Though not a silver bullet, cash flow data use could be one strategy among many for boosting homeownership among households of color and reducing racial inequality in the mortgage system.
Still, many barriers remain that prevent the widespread adoption of this kind of data. Thoughtful guidance from federal regulators can help minimize risk and ensure both lenders and consumers feel comfortable using rental payment data in the credit scoring and mortgage underwriting processes.