Credit History and the FHA-Conventional Choice

Anthony Pennington-Cross and Joseph Nichols

Zell/Lurie Center Working Papers from Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania

Abstract: Models of household choice of conventional and FHA financing typically use differential insurance premiums, loan to value and payment to income underwriting standards, and local economic conditions to explain household behavior. The credit history of the borrower has not been included in these models. In this paper we expand the standard conditional FHA choice model by including various measures of borrower credit history using a sample of over 40,000 loans from 40 MSAs. We find that the ability of a homebuyer to avoid credit problems in the past is an important indicator of the FHA-conventional choice, but borrower demographic characteristics, location, downpayment, and income also play a significant role. For instance, a one standard deviation increase in the FICO score decreases the odds of choosing FHA financing by approximately 95%. In short, credit history is a powerful indicator of the FHA-conventional choice In addition, we test for differences in credit history distributions across different sub-samples of homebuyers. While FHA borrowers do have lower FICO scores on average, there is a substantial overlap of scores. As LTV rises, conventional and FHA FICO score distributions become more alike. In general, FICO scores improve when LTV and PTI are lower and income is higher.

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