2011 could be the first year in which large numbers of consumers receive free disclosures of their credit scores. I am not talking about the offers that involve signing up for a credit monitoring product, or the free credit scores that some financial institutions or websites offer. While I believe those services (including Credit.com’s truly free credit report card) can be enormously useful, two laws – one old and one new – may put the scores lenders actually use into the hands of a lot more people.
The first free credit scores could start being handed out as early as January 1, 2011 under what’s called “risk-based pricing rules” that implement provisions found in the Fair and Accurate Transactions Act of 2003 (FACTA).
Here’s how it works: Let’s say you see an offer for a credit card, car loan or mortgage at an attractive rate. You apply, but because of information in your credit score, you are approved at a higher rate than the low rate you saw advertised. Or maybe you are offered that rate, but you’ll have to pay points or fees to get it. Under the risk-based pricing rules, the lender may be required to send you a notice telling you that you did not qualify for the best rate and telling you how to get a free copy of your credit report. No credit score is required in this notice, which must be delivered to the applicant after he or she applies, but before financing is accepted.
However, the rules for figuring out who must receive risk-based pricing notices are a bit complicated. Lenders can either use a 60/40 calculation where those with scores that put them in the lower 60% of customers get the notices, or they can divide customers into tiers and all but those in the top tiers get the notices. I am oversimplifying this calculation, which for some lenders can be a real headache, not to mention the fact that it must be updated
So there is an alternative. Instead of trying to figure out who falls into which category, a lender can provide disclosure to everyone who applies. That disclosure must include the applicant’s credit score along with a required explanation of the score, plus instructions on how the consumer can order a free copy if his or her credit report from AnnualCreditReport.com.
Click to view sample disclosure
Dan Doman, Vice President and General Counsel for RouteOne LLC, a firm that provides auto dealers with a free automated process to generate the required credit score disclosure notices, says that 100% of the auto dealers he’s talked with have indicated they are going to provide the credit score notice. “It’s the best tool for consumers, it meets the requirement of the regulation, and it’s not overly burdensome.” He also pointed out that dealers often work with several financing sources, which would make using the other methods challenging at best. According to FICO, the top 25 largest auto lenders use their scores, so that means consumers who apply for financing at a dealer who provides credit score disclosures are likely to get their FICO scores.
Risk-based pricing notices don’t just apply to consumers who apply for credit, though. They also can apply in situations where credit card issuers review existing accounts and decide to raise cardholder’s rates because their credit ratings have deteriorated.
However, they do not apply to business credit, and are not required when lenders don’t use risk-based pricing. According to Anthony Demangone, Director of Regulatory Compliance for NAFCU, many credit unions don’t employ risk-based pricing. It’s also worth noting that employers do not use credit scores, only credit reports.
Overall, this is a big deal because consumers currently don’t get many opportunities to peek behind the curtain and see what types of credit scores lenders are actually using to approve or deny applications.
The second opportunity to get free credit score disclosures will come July 21, 2011 when Senator Mark Udall’s Free Access to Credit Scores (FACS) legislation takes effect. Part of the Dodd-Frank Wall Street Reform Act, it requires lenders to disclose credit scores in the case of “adverse action.” This includes situations where consumers are turned down for credit or insurance based on their credit scores, but it also includes situations where they must pay a higher deposit or interest rate, or get a cosigner in order to qualify. While adverse action notices have been required by law for years, they have previously only included the major reasons for the adverse action, but no scores. New disclosures under FACS must include the score used by the lender. Note there is no overlap, as risk-based pricing notices are not required in situations where an adverse action notice must be sent.
While we’re not yet at the point of free credit scores for all, that day could be coming. Senator Udall has also sent a letter to Elizabeth Warren urging her to make free credit scores a priority for the Consumer Financial Protection Bureau.
In the meantime, the new regulation should mean a better informed consumer. “It provides the consumer with a tool with which they can compare offer to offer. It also allows the dealership a tool to explain why the financing is the way it is,” says Doman. “This is one time where the regulators actually got it right.”
Note: My description of the risk-based pricing notices is highly simplified. You can read the whole 200+ page risk-based pricing notice rule here.
Image by mollycakes, via Flickr