During the peak of the housing bubble most if not all loan decisions were made based entirely on the borrower’s credit scores. In other words, loans were made on a borrower’s ‘propensity’ to pay, not necessarily their ‘ability’ to pay. (I.E. no income documentation or ‘Liar’s Loans’.)
As long as the housing boom continued and values climbed, nobody, especially the banks who made the loans, would get hurt. As we have now learned however, what goes up must come down, and what booms must eventually bust.
The new loan paradigm will be primarily concerned about a borrower’s ability to pay. While a good credit score will still undoubtedly be important, it will be subordinate to traditional methods of income, asset, and employment verification.
Already there are a slew of ‘solution providers’ working to warehouse income, asset, and employment information for all of us. This information will supplement our credit scores. One solution involves employers and the IRS delivering information to third parties. Another involves mathematical ‘predictors’ and software tools to affirm self-reported data.
While this is a return to more traditional lending practices, big brother will be watching, and we will have to be vigilant about ensuring our new ‘permanent record’ is accurate, just as we do our credit reports.