New consumer credit rules protect against excessive rates
WASHINGTON — For mortgage applicants and home purchasers, the Federal Trade Commission and the Federal Reserve finally have come out with important consumer credit protection rules. We've only had to wait six years.
In late December, the two agencies published regulations designed to safeguard loan applicants from needless overcharges caused by erroneous or outdated negative information in their national credit bureau files.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.
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The problem, though, is that credit bureau files sometimes contain junk entries — mistaken or outdated reports of late payments, unpaid bills, chargeoffs and judgments that can severely depress credit scores.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 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. The entire subprime mortgage industry, which lit the fuse for what eventually became the housing bust, rested on lenders' ability to charge borrowers with low credit scores far more than they would charge consumers with prime scores.
Concerned that many loan applicants were being hit with excessive rates for no reason, Congress in 2003 passed the Fair and Accurate Credit Transactions Act. Among a long list of other reforms, that law introduced the concept of free annual credit reports for everyone and directed the FTC and the Fed to come up with a new "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 red-flag consumers about credit file complications before they were legally bound to a loan deal that might be overpriced. President George W. Bush signed the legislation on Dec. 4, 2003. It took the FTC and the Fed until May 2008 to draft proposals, and 19 more months to come out with their final regulations for lenders.
What will risk-based pricing notices mean in practical terms? Though the mandatory start date isn't until Jan. 1, 2011, some lenders are expected to begin phasing in the notice system this year.
The rules offer several alternatives, but mortgage lenders are likely to provide consumers with notices including their credit scores, a bar graph that shows where their scores rank with other consumers, the name and contact information for the credit bureau that provided the information, key factors that may have lowered the score and guidance on how to correct mistakes in credit files.
In 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 before any application by visiting 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 fees.
Ken Harney can be reached at firstname.lastname@example.org.