January 11th, 2010 12:12 PM by Lehel S.
Reporting from Washington - For mortgage applicants and home buyers, it's been a six-year wait, but the Federal Trade Commission and the Federal Reserve finally have come out with consumer credit protection rules first required by Congress in 2003.In late December, the two agencies published regulations designed to safeguard loan applicants from overcharges on interest rates caused by erroneous or outdated negative information in their national credit bureau files.The rules require lenders to alert consumers when derogatory credit data cause them to be charged higher rates and down payments or receive less than optimal terms on a "risk-based pricing" system. Risk-based pricing tied to credit scores is standard practice for 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the higher your costs.The problem, though, is that credit bureau files sometimes contain junk entries -- mistaken or outdated reports of late payments, unpaid bills, charge-offs and judgments that can severely depress credit scores.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 exist.For years, the only way loan applicants learned of a problem was a rejection letter from a lender turning down their mortgage request. 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 spread of risk-based pricing systems, fewer applicants were formally declined loans; lenders simply raised rates to handle the perceived risk. The subprime mortgage industry -- which lit the fuse for the housing bust -- depended on the ability of lenders to charge borrowers with low credit scores far more than they'd charge consumers with prime 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 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 "risk-based pricing notice" for 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. No one knows how many overpriced subprime mortgages might have been averted had risk-based pricing notices been available to consumers in 2004, 2005 and 2006. But the FTC and the Fed never came up with draft proposals to implement Congress' mandate until May 2008. Nineteen months later -- on Dec. 22, 2009 -- the agencies came out with their final regulations for lenders, and even those won't be mandatory for another year.What will risk-based pricing notices mean for mortgage applicants? Though the 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 mortgage lenders are likely to provide consumers with notices including their credit scores, a bar graph representation 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, plus guidance on how to correct mistakes in credit files.In the coming months, home loan shoppers should ask lenders how they handle pricing when scores come in low. Ask whether the lender will tell you if something in your files is raising your rates. You should also get a free credit report at www.annualcreditreport.com. This is especially important in 2010 because virtually all major mortgage sources have raised their credit score cutoffs for the best rate quotes and fees.