One of the U.S.'s largest housing finance firms is testing alternative data to better evaluate borrowers seeking to secure a mortgage.
Freddie Mac has been using underwriting software from financial technology firm ZestFinance Inc., a partnership first reported by The Wall Street Journal. That software, which looks at data beyond the traditional credit score and purports to evaluate it differently, could make mortgages more available for certain applicants, including first-time home buyers and minorities, said people familiar with the matter.
The Los Angeles, Calif.-based startup develops artificial intelligence software to enable financial companies to access thousands of additional data sources to better evaluate the risk that an applicant will not repay a loan. Whereas conventional methods of credit scoring rely on about 20 to 50 variables, artificial intelligence can consume an infinite number of variables and is more resilient to data that might be messy or not always accurate, a person familiar with the matter said. ZestFinance has launched models with tens of thousands of variables. Mortgage borrowers who could benefit from the software include those with low credit scores, high debt levels or other red flags less likely to fare well with the traditional credit score.
Freddie's standards strongly affect the entire mortgage market, so its acceptance of what has been dubbed alternative data would go a long way toward securing mainstream acceptance of these newer methods.
"AI was considered this very advanced, fancy technology for companies like Facebook and Google and [other companies that] would have been considered cutting edge in their adoption of technologies," one person said in an interview. "What you're seeing now is some really top-brass, traditional best-in-class financial institutions rolling this out."
Freddie has been testing the ZestFinance software for several months, but the partnership extends further back, said the people, who wished to remain unnamed because details of the partnership are not public. The two companies met with the Federal Housing Finance Agency several months ago to discuss the underwriting software, according to people familiar with the matter.
"There has been nothing but positive signals from FHFA with respect to [Freddie's] move" into artificial intelligence, one person said. The regulator declined to comment.
In addition to being one of the largest mortgage companies in the country, Freddie also helps run the infrastructure that underlies the U.S. housing finance system. Freddie and its fellow government-sponsored enterprise Fannie Mae have been the subjects of intense political debate after the Trump administration announced its intention to return the two companies to private ownership.
The federal government took the two firms into conservatorship during the 2008 financial crisis. But the Treasury Department and the Department of Housing and Urban Development earlier in September released their respective proposals to recapitalize the firms, ending their 11-year conservatorships.
The two firms have to grapple with their government mandate to expand mortgage originations to more Americans, while doing so in a way that does not increase their risk, as elevated risk exposure nearly caused their collapse a decade ago. A partnership with ZestFinance could give Freddie a significant competitive edge over Fannie, if the use of alternative data and artificial intelligence proves beneficial. In the second quarter, the two GSEs purchased and securitized 38.6% of mortgages, according to nonprofit research firm Urban Institute.
Fannie and Freddie have long experimented with ways to make home loans more available to borrowers, including offering certain first-time home buyers a mortgage with just 3% down payment. In 2018, the companies also piloted a program to change how borrowers without large down payments pay for mortgage insurance.
