When you’re quoted a higher interest rate than you deserve because of information in your credit file, wouldn’t you appreciate it if someone red-flagged it for you?
That’s an especially pertinent question in today’s mortgage market, as lenders ratchet up their credit score minimums and use electronic “risk-based pricing” to set rates and other loan terms. If you really deserve a 720 FICO credit score but you have been pulled into the low 600s because of incorrect or missing information in your national credit-bureau files, you ought to know so you have the opportunity to fix the problems.
To help with this, two federal agencies have proposed risk-based-pricing alerts that would cover all lending situations, including home mortgages, credit cards and auto loans. As part of credit legislation enacted at the end of 2003, Congress directed the Federal Reserve and the Federal Trade Commission to devise a system that would require lenders to notify consumers whenever the contents of their credit files contribute to a less favorable credit offer than the borrower might otherwise receive.
It took four years, but the two agencies published their proposal for a risk-based-pricing alert in mid-May. After a three-month comment period open to the public and affected industry groups, the FTC and the Fed could adopt the plan later this year.
Here’s how it might work for home mortgage applicants: The bank pulls your credit files and prepares a rate quote. If your score comes in too low to qualify for the lender’s best deals, the loan officer would be required to use one of several methods to notify you.
Using one method, the bank could provide you the credit score that governed your rate quote, along with a graphic representation of how your score compares with those of other mortgage applicants, plus the key factors in your file that depressed your score. The notice would also include information on how to contact the credit bureau that provided the score and how to obtain your full credit report.
Because you wouldn’t yet be contractually committed on the mortgage, you would be free to call a timeout and check what’s in your credit files. If derogatory information is erroneous, or if some of your creditors had failed to report your on-time accounts to the national bureaus, you would be able to correct the files before proceeding.
Not all applicants would be issued risk-based-pricing notices under the proposal — only those whose mortgage terms and rate quotes are “materially less favorable than the most favorable terms available to a substantial portion of consumers [obtaining credit] from or through” that lender.
The FTC and the Fed offered two methods for lenders to determine which applicants fit that description. Using one approach, lenders would set a credit-score cutoff at which about 60 percent of customers have lower scores and about 40 percent have higher scores. Only loan applicants with scores below the cutoff would have to receive the alerts.
Under a second alternative, lenders would create a tiered pricing structure, with notices required only for applicants whose scores are in the lowest tiers. For example, if a lender used five pricing gradations, only applicants who fell into the lowest three tiers would receive an alert.
In a key decision that could provoke debate, the FTC and the Fed would not require most mortgage brokers to issue notices, as long as they do not function as lender during a transaction but are solely intermediaries. If the agencies’ proposal is adopted, that means that when brokers shop loan applications to multiple lenders and receive quotes, they will not need to provide multiple risk-based-pricing notices.
In another limitation, the two agencies conceded that some consumers might not receive notices even though negative information in their files depressed their scores. That’s because mortgage brokers might send applications with seemingly subprime credit exclusively to lenders who specialize in subprime loans. In that event, an applicant’s high rate quote may be typical for that lender, not “materially less favorable” than what the bulk of the lender’s clients receive.
Whatever the shape of the final plan for a risk-based-pricing alert, it almost certainly will heighten consumer awareness of the importance of credit data in determining mortgage rates and terms. In the meantime, remember this: Always check at least one of your national credit bureau reports — on file with Equifax, Experian and TransUnion — months before applying for a mortgage.
That allows you the time to fix problems if necessary and qualify for the rate you deserve.
By Kenneth R. Harney
CreditScoreQuick.com
