The Washington Post
January 9, 2010
For mortgage applicants and home purchasers, it has been a six-year wait, but the Federal Trade Commission and the Federal Reserve finally have come out with important consumer credit protection rules first required by Congress in 2003.
In late December, the two agencies published regulations designed to safeguard loan applicants from needless overcharges on interest rates caused by erroneous or outdated information in their national credit bureau files.
The rules require lenders to alert consumers whenever derogatory credit data cause them to be charged higher rates, higher down payments or less than optimal terms on a "risk-based pricing" system. Risk-based pricing tied to credit scores is standard practice for home mortgages, credit cards, auto loans and most other financial products offered to the public.
Generally, the higher your credit score, the lower the rates and fees you're quoted. The lower your scores, the higher your costs of credit.
The problem, though, is that credit bureau files sometimes contain junk entries -- mistaken or outdated reports of late payments, unpaid bills, charge-offs and judgments that can severely depress credit scores. Consumers have the right to demand correction of these errors but frequently have no idea that they even exist.
For years, the only way loan applicants learned of a problem was a rejection letter from a lender. At that point, federal law guaranteed them the right to receive an "adverse action" notice, encouraging them to check their credit files for possible errors.
But with the rapid spread of risk-based pricing systems, fewer applicants were formally declined for loans; lenders simply raised rates to handle the perceived higher risk. The entire subprime mortgage industry -- which lit the fuse for what eventually became the housing bust -- rested on the ability of lenders to charge borrowers with low credit scores far more than they would charge consumers with high scores.
Concerned that many loan applicants were being hit with excessive rates for no good reason, Congress in 2003 passed the Fair and Accurate Credit Transactions Act. Among a long list of other reforms, the law introduced free annual credit reports for everyone and directed the FTC and the Fed to come up with a risk-based-pricing notice for mortgage and other loan applicants whenever their credit scores triggered high interest rates or other adverse terms.
The idea was to give consumers a red flag about credit-file complications before they were legally bound to a loan deal that might be overpriced. President George W. Bush signed the law Dec. 4, 2003. No one can even venture a guess at how many overpriced subprime mortgages during the housing boom might have been averted had risk-based-pricing notices been available to consumers in 2004, 2005 and 2006. But the FTC and the Fed didn't come up with draft proposals to implement Congress's mandate until May 2008. Nineteen months later, on Dec. 22, the agencies came out with their final regulations for lenders, and even those won't be mandatory for another year.
When critics -- including myself -- complained of foot-dragging in recent years, the FTC said staffers were busy drafting other rules to implement the many requirements of the 2003 legislation. In the December announcement of the final rules, the FTC and the Fed noted that they conducted "in-depth outreach" to "interested parties," including lenders, credit reporting agencies and consumers.
Putting aside the six-year span between congressional mandate and final regulation, what will risk-based-pricing notices mean for consumers applying for mortgages? Though the mandatory start date is not until next Jan. 1, some lenders are expected to begin phasing in the new notice system this year.
The rules offer several alternatives, but home mortgage lenders are likely to provide consumers with notices including their credit scores, a bar graph allowing them to see where their scores rank against other consumers, the name and contact information for the credit bureau that provided the information, key factors that might have lowered the score, and guidance on how to correct mistakes in credit files.
During the coming months, home loan shoppers should ask competing lenders how they handle pricing when scores come in low. Ask whether the lender will inform you if something in your files is dragging down your scores and raising your fees and rates. You should also request a free credit report in advance of any application by visiting http://www.annualcreditreport.com. This is especially important in 2010 because virtually all major mortgage sources -- including Fannie Mae and Freddie Mac -- have raised their credit-score cutoffs for the best rate quotes and lowest fees.