CUNA Regulatory Comment Call
May 27, 2008
Proposal to Require Creditors to Provide Certain Consumers with Risk-Based Pricing Notices
- The Fair and Accurate Credit Transactions (FACT) Act of 2003 amends the Fair Credit Reporting Act (FCRA), which regulates the collection, dissemination, and use of consumer credit information. The proposed rule would implement the section of the FACT Act which requires risk-based notices.
- The Federal Reserve Board (Fed) and Federal Trade Commission (FTC) have jointly proposed a new rule that would require creditors to provide consumers with risk-based pricing notices in certain circumstances.
- More specifically, such a notice would be required when, based on the consumer's credit report, the creditor offers credit to the consumer on terms that are materially less favorable than those offered to a substantial proportion of other consumers by that lender. The rule provides certain exceptions to this requirement.
- Comments in response to this notice of proposed rulemaking are due by August 18, 2008; please submit your comments to CUNA by August 7.
Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Senior Vice President and Deputy General Counsel Mary Dunn at firstname.lastname@example.org and to Regulatory Research Counsel Luke Martone at email@example.com; or mail them to Mary and Luke in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, South Building, Suite 600, Washington, DC 20004-2601. You may also contact us at 800-356-9655, ext. 6732, if you have questions or would like a copy of the proposed rule. You may also access a copy of the proposed rule here.
The FACT Act was enacted in December 2003 and permanently extends the federal preemptions for credit reporting under the FCRA. Additionally, the FACT Act enhances the ability of consumers to combat identity theft, increases accuracy of credit reports, and allows consumers to exercise greater control regarding the marketing solicitations they receive. The Fed and FTC have issued a proposal that would implement the section of the FACT Act that requires risk-based notices be sent to consumers in certain instances.
Risk-based pricing refers to the practice of setting or adjusting the price and other terms of credit offered to a consumer to reflect the risk of nonpayment by that consumer. The primary objective of requiring a notice is to alert consumers to the existence of negative information on their consumer reports so that they can check their reports for any inaccuracies.
BRIEF DESCRIPTION OF THE PROPOSED RULE
I. General Requirements
For creditors that use risk-based pricing when offering credit, the proposal will require them to provide notice to certain consumers. More specifically, a notice must be given to a consumer when the creditor: 1) uses a consumer report in connection with an application or extension of credit to a consumer; and 2) based on that report grants or extends credit to that consumer on material terms that are materially less favorable than the most favorable terms available to a substantial portion of consumers by that creditor. A "substantial portion" does not have to constitute a majority of consumers.
The proposal would only cover credit to a consumer that is primarily for personal, family, or household purposes and would require that only one notice be given to the applicant in connection with a less favorable offer, although a notice may be required later if the terms change due to an account review, as described below. The creditor responsible for providing that notice would be the "original creditor." The original creditor is that entity to whom the obligation is initially payable. For example, an auto dealer would provide the notice if it provides the loan even if it later assigns it to another creditor. However, a financial institution would provide the notice if it is funding the loan directly, even if application is made at the dealership.
The proposed rule defines certain key terms. Specifically, "material terms" will be defined as the annual percentage rate (APR), excluding the temporary initial rate and any penalty rates. For credit cards, the APR is the purchase rate. For credit without an APR, it will be defined as any monetary term, such as the down payment amount or deposit, that varies based on the consumer report.
Another key definition is that of "materially less favorable," which is generally defined as when a creditor imposes a higher cost for credit for one consumer that is "significantly greater" than the cost of credit being imposed for other consumers. However, different creditors are permitted to reach different conclusions as to whether certain APRs are "materially less favorable."
Application to Credit Cards
In general, a risk-based pricing notice must be sent to applicants of credit cards if:
- The consumer applies for a credit card in connection with a program for which more than a single possible purchase APR apply; and
- Based on that consumer's report, the card issuer provides the consumer with a credit card with a purchase APR that is not the lowest purchase APR available under that application or solicitation. (This provision of the proposed rule is written on the assumption that when a credit card issuer offers a range of rates within a single solicitation, the consumer applies for the best available rate.)
The following are two exceptions to the notice requirement regarding credit cards.
- If the consumer applies for a credit card for which the creditor provides a single purchase APR; and
- If the consumer is offered the lowest purchase APR available under the credit card offer for which he or she applied, even if the issuer offers lower rates under a different credit card offer to other consumers.
II. Methods for Determining who Receives Notice
In order to determine whether a consumer has received materially less favorable terms than that of a substantial proportion of other consumers from that creditor, the proposal offers three different methods. A creditor must then provide a risk-based pricing notice to these consumers. The same method must be used by a creditor to evaluate all consumers receiving a specific type of credit but may vary the methods among different products. For example, a creditor may use one method for mortgages and a different method for auto loans.
The first method is a direct consumer-to-consumer comparison; this involves comparing each consumer to an adequate sample of consumers who have engaged in similar transactions.
Credit Score Proxy Method
The second approach is the credit score proxy method. Under this method a creditor that sets the material terms of credit granted to a consumer, based on a credit score, may comply with the risk-based notice requirements by: 1) determining the credit score that represents the point at which approximately 40 percent of its consumers have higher credit scores and approximately 60 percent of its consumers have lower credit scores, and 2) providing a risk-based pricing notice to consumers with a score below this cutoff score. Under this approach, a consumer would receive a notice even if he or she receives the most favorable terms.
The proposal permits two methods for determining the cutoff score. The generally required method is the sampling approach. This approach provides that a creditor currently using risk-based pricing with respect to credit products must calculate the cutoff score by considering the credit scores of all or a representative sample of the consumers to whom it has granted credit for a given class of products. The sampling approach will not be suitable for all creditors, such as new entrants into the credit business. Such creditors may initially use the secondary source approach to determine their cutoff score. This score would be based on information from appropriate market research or relevant third-party sources for similar products.
Creditors using the sampling approach will need to recalculate their cutoff scores at least every two years. Creditors using the secondary source approach will be required to recalculate their cutoff score based on a representative sample of its own consumers within one year after it begins using a cutoff score derived from third-party source data. A user of the secondary source approach who does not grant credit to a sufficient number of new consumers during that one-year period, therefore lacking sufficient data to recalculate its cutoff score, will be permitted to continue to use a cutoff score derived from third-party source data until it obtains sufficient data of its own.
If in using the proxy method a creditor uses two or more scores in setting the material terms of credit granted, the creditor must determine the appropriate cutoff score based on how that creditor evaluates the multiple credit scores when making credit decisions. If when using multiple scores, the creditor uses inconsistent methods for evaluating those scores, the creditor would be required to use reasonable means to determine the appropriate cutoff score. The proposal would establish a safe harbor for a creditor that uses either a method that the creditor regularly uses or the average credit score for each consumer as the means of calculating the cutoff score.
In addition, if a creditor is using the proxy method for a consumer in which a credit score is unavailable, the creditor must assume that that consumer is receiving credit on less favorable terms and should therefore provide a risk-based pricing notice.
Tiered Pricing Method
The last approach is the tiered pricing method. A creditor using this method may place the consumer within one of a discrete number of pricing tiers based on a consumer report. The only factor a creditor using this method must consider is tiers with different APRs or, for credit with no annual percentage rate, other monetary terms that the creditor varies based on consumer report information. A notice must be sent to those consumers who do not qualify for the top (lowest-priced) tier for a four or fewer tier system, or the top two tiers for a five or more tier system, as well as additional tiers that comprise between 30-40% of the total number of tiers.
If a creditor uses different pricing tiers for different products, a separate analysis will need to be done for each product for which different tiers apply. This method focuses only on the number and percentage of tiers, not on the number or percentage of consumers assigned to each tier. Lastly, a creditor using this method may not consider tiers for which no consumers have or are expected to qualify, nor may the creditor consider a top tier that is available only to those with perfect or near-perfect credit which the creditor rarely uses.
III. Content, Form, and Timing of Notice
The notice must generally be provided before the consummation of the transaction, or the first transaction for credit cards or other open-end credit, but no earlier than the time that approval of the credit is communicated to the consumer. Notice is not required if the consumer applied for specific material terms and was granted those terms, unless those terms were initially specified by the creditor after obtaining a consumer report.
The risk-based pricing notice would need to:
- State that the terms offered are based on information from that consumer's report;
- Identify the consumer reporting agency providing the report;
- State that the consumer may obtain a free consumer report from that agency within 60 days after receipt of the notice, which would be in addition to the free credit report that consumers are already entitled to receive under the FACT Act; and
- Include a statement informing the consumer how to obtain the free report from the reporting agency-the notice should also include a toll-free number, if applicable, for each reporting agency.
The proposed rule would also require that the notice include a statement that the terms offered "may" be less favorable than those offered other consumers with better credit histories; the proposal would not require language stating that the terms "are" or "will be" less favorable. The Fed and FTC believe that including such a statement could encourage consumers to check their consumer reports for inaccuracies.
Additionally, the notice would need to explain that a consumer report includes information about a consumer's credit history and the type of information included in that history. A statement indicating that the consumer has the right to dispute any inaccurate information in the report would also be required.
The proposed rule would also apply to the account review process. Under the proposal, a notice must be provided to a consumer if the creditor: 1) uses a consumer report in connection with a review of credit that has been extended to the consumer; and 2) based on that report, the creditor increases the APR. Similarly, a notice must be provided if a credit card issuer periodically obtains consumer reports in order to review the terms of the credit it has extended to a consumer and based on that review increases the APR.
Notices issued in response to account review must include the same basic information as notices provided for credit applicants, such as a statement that a consumer report includes information about the consumer's credit history. These notices must be provided at the time the decision to increase the APR is communicated to the consumer, or no more than five days after the increase if no such notice is provided.
IV. Exceptions to the Rule
A risk-based pricing notice is not required if the consumer applies for and is granted specific terms for credit, unless those terms were specified after the credit was applied for and after the creditor obtained a consumer report. As described below, the proposal also includes three additional exceptions for creditors if they provide credit score information to consumers. In general, these credit score disclosures must include the score and additional information regarding the use of consumer reports and credit scores during the underwriting process.
Credit Score Disclosure Exception for Mortgage Loans
Under other provisions of the FACT Act, creditors are required to provide a credit score disclosure to consumers in connection with mortgage loans. Instead of requiring creditors to include the standard risk-based pricing notice for such loans, the proposed rule would allow creditors to add certain supplemental disclosures to the already required disclosure. These creditors could provide this integrated notice to all consumers for such loans and would not be required to do a comparison of terms offered to different consumers, as is required by the general rule.
As proposed, in order to qualify for this exception, the integrated notice would need to disclose certain information, including statements describing that:
- A consumer report is a record of the consumer's credit history and includes information about whether the consumer pays his or her obligations on time and how much the consumer owes to creditors;
- A credit score is a number that takes into account information in a consumer report and that a credit score can change over time to reflect changes in the consumer's credit history;
- The consumer's credit score can affect whether the consumer can obtain credit and the cost of that credit;
- The consumer is encouraged to verify the accuracy of the report and can dispute any inaccuracies;
- The consumer may obtain his or her consumer report, with information as to how this may be retrieved; and
- In order to put the consumer's credit score in context, either a distribution of credit scores or a statement about how the consumer's score compares to others'.
To elaborate on the contextual requirement noted above, the integrated notice would need to show the consumer how his or her credit score compares to the score of other consumers. This would be accomplished by either a concise narrative statement informing the consumer that his or her credit score ranks higher than a specified percentage of consumers or by using a distribution of credit scores. A distribution can be presented in a bar graph containing a minimum of six bars, or by a different form of graphical presentation that is clear and readily understandable. If a bar graph is used, each bar must illustrate the percentage of consumers with credit scores within the range of scores reflected by that bar.
The integrated notice would also need to contain all of the information that is already required to be disclosed under the other provisions of the FACT Act, including:
- Current credit score of the consumer or the most recent score that was previously calculated for the extension of credit;
- Date which that score was created;
- Name of the person that provided the credit score;
- Range of possible credit scores under the model used; and
- Up to four key factors that adversely affected the consumer's credit score.
Creditors relying on this exception generally are required to provide to the consumer a credit score that was used in connection with the credit decision. If, however, the creditor uses a credit score not created by a consumer reporting agency, such as a proprietary score, that creditor may satisfy the exception by either providing the proprietary score or by providing a credit score and associated information obtained from an entity regularly engaged in the business of selling credit scores. Additionally, a creditor that does not rely on a credit score in its credit evaluation process may use this exception by purchasing and providing to the consumer a credit score and associated information obtained from an entity regularly engaged in such business.
In order to satisfy this exception, the integrated notice must be provided at or before consummation of a transaction in the case of closed-end credit or before the first transaction under an open-end credit plan.
Credit Score Disclosure Exception for Non-Mortgage Credit
There will also be a credit score disclosure exception for loans not secured by residential property. This exception can be used, for example, by auto lenders, credit card issuers, and student loan companies. Creditors offering these types of loans may also comply with the regulations by disclosing a consumer's credit score along with certain additional information.
Similar to the above-described mortgage exception, creditors using this exception must still send a notice must be sent to the consumer containing certain contextual information as well as general disclosures about credit scores. Also consistent with the above exception, a creditor that uses a credit score not created by a consumer reporting agency may satisfy the exception by either providing the score obtained or by providing the consumer with a credit score and associated information it obtains from an entity regularly engaged in the business of selling credit scores.
The notice must disclose, by clear and readily understandable means, either a distribution of credit scores or a statement about how a consumer's score compares to others, as required for the mortgage exception. The timing of the notice for this exception is the same as that for the above described mortgage exception.
Credit Score Disclosure Exception When No Credit Score is Available
The proposal includes an exception to the notice requirement for creditors that regularly use the credit score disclosure exceptions in the two above situations-mortgage and non-mortgage loans-when the credit score for a particular consumer is unavailable.
In order to utilize this exception, the creditor must:
- Regularly obtain credit scores from a consumer reporting agency;
- Regularly provide credit score disclosures to consumers in accordance with the two above described exceptions; and
- Be unable to obtain a credit score for the particular consumer from the consumer reporting agency the creditor regularly uses.
The creditor will not be required to seek a credit score from another consumer reporting agency if the agency which it regularly uses does not have a credit score for that particular consumer. Additionally, a creditor that regularly requests a particular type of credit score from a consumer reporting agency to provide to consumers to satisfy the requirements of the two above exceptions need not obtain a different type of credit score than what he or she regularly uses.
If a creditor utilizes this exception, he or she must still provide the consumer with a notice containing the same disclosure information as the two above described exceptions. In addition, the notice must include a statement that the consumer is encouraged to verify the accuracy of the information in the consumer report and has the right to dispute any inaccuracies. The notice must also state that the consumer has the right to obtain copies of his or her report directly from the consumer reporting agency.
The notice under this exception must be provided to the consumer as soon as reasonably practicable after the credit score has been requested, but in any event at or before consummation of a transaction in the case of closed-end credit or before the first transaction is made under an open-end credit plan.
The proposed regulation would also include an exception for prescreened solicitations. A creditor would not be required to provide a risk-based pricing notice if the creditor obtains a consumer report that is a prescreened list and uses that report to make a firm offer of credit to the consumer. In these circumstances, it should not matter to the consumer how the material terms of such an offer differ from the terms that the creditor includes in other firm offers of credit to other consumers, and it would be burdensome to impose a notice requirement on creditors in these situations since most consumers do not respond to prescreened solicitations.
V. Model Forms
The proposed rule contains model forms that the Fed and FTC have prepared that will comply with these notice requirements.
A creditor may use clear and readily understandable means, other than the bar graph models suggested, to disclose the distribution of credit scores under the credit score exception for mortgage loans. As mentioned in Section IV, a creditor may alternatively include a short narrative statement such as that in models H-3, H-4, B-3, and B-4, to disclose how a consumer's credit score compares to the scores of other consumers. Creditors have the option of changing the format of the model forms, as long as the substance of the notice is not changed.
QUESTIONS TO CONSIDER REGARDING THE PROPOSED RULE TO REQUIRE RISK-BASED PRICING NOTICE
(The Agencies have specifically requested comment on the issues raised in these questions.)
- Are there any circumstances under which creditors should be required to provide risk-based pricing notices in connection with credit primarily for business purposes?
- Is the proposed definition of "materially less favorable" helpful? Should the interrelated terms "most favorable terms" and "a substantial proportion of consumers" also be defined and, if so, how should it be defined?
- Do creditors vary temporary initial rates, penalty rates, balance transfer rates, or cash advance rates, on either closed-end or open-end credit, as a result of risk-based pricing? If those rates do vary as a result of risk-based pricing, should any of them be treated as "material terms," in addition to the general APR, and would it be possible to apply to those rates the existing tests-consumer-to-consumer comparison, credit score proxy method, and tiered pricing method? If new tests would be required under such a broader definition of "material terms," what might those tests be?
- The Agencies solicit comment as to whether the definition's reference to "any monetary terms" that the creditor varies based on information from a consumer report is sufficiently specific or too broad.
- Should intermediaries who are not original creditors, such as brokers, be required to provide risk-based pricing notices to consumers based upon the intermediaries' decisions regarding the shopping of consumer credit applications to certain creditors that generally offer less favorable terms and, if so, how could such a requirement be structured?
- Will the credit score proxy method generally result in risk-based pricing notices being provided to consumers who are likely to have received materially less favorable terms? Will setting the cutoff score at approximately the point at which 40 percent of a creditor's consumers have higher scores and 60 percent have lower scores be appropriate and workable, or should a different point, such as the point at which 50 percent of a creditor's consumers have higher scores and 50 percent have lower scores, be more appropriate? Do you know of any empirical data regarding the point at which consumers typically begin to receive materially less favorable terms that may suggest the most appropriate point at which to set the cutoff score?
- What should the requirements be to recalculate the credit score cutoff, specifically regarding whether two years, as opposed to a shorter or longer period, is the appropriate interval at which the recalculation generally should be conducted? Is one year the appropriate period of time within which a person using the secondary source approach must recalculate its cutoff score using the sampling approach? The secondary source approach is determining the appropriate cutoff score based on information derived from appropriate market research or relevant third-party sources for similar products.
- Regarding the credit score proxy method, when a consumer's credit score is not available, the Agencies have proposed an assumption that the consumer receives credit on less favorable terms than other consumers and should therefore receive a risk-based pricing notice. Is this an accurate assumption? If no credit score is available, are there other reasonable means by which a creditor may determine whether the consumer received materially less favorable credit terms?
- Should the tiered pricing method take into account the percentage of consumers placed in each tier and how could that be accomplished without creating undue burdens or introducing excessive complexity to the tiered pricing method?
- Could the tiered pricing method be subject to such circumvention by creditors and how can that be prevented?
- The proposed rule would require that the risk-based pricing notice contain a statement alerting consumers that a free consumer report can be obtained for 60 days following receipt of the notice. Is it appropriate to require disclosure of the 60-day period in the notice?
- Should the notice state that the terms "may be" less favorable, as proposed, or should a different phrase be used, such as that the terms "are likely to be" less favorable? What language would best serve the dual goals of most accurately describing the probability that the consumer received materially less favorable terms while prompting consumers to obtain and review their consumer reports?
- Are there any circumstances in which the notice should be permitted to be provided after consummation or after the first transaction under the plan, and would notice provided after consummation or after the first transaction under the plan be effective for consumers?
- Is the bar graph form of disclosure for the mortgage loan credit score exception (see Section IV) the simplest and most useful form of disclosure for consumers, or are there different graphical or other means that would provide greater consumer benefit? Should the rule set forth other examples of specific methods of presenting the score distribution or score comparison, such as a narrative, a statement of the midpoint of scores, or different forms of graphical presentation?
- Would the disclosures of the credit score creation date and the source of the score be beneficial to consumers or would it impose undue burdens on the industry?
- Would requiring disclosure of the key factors that adversely affected the credit score in the credit score notice be helpful to consumers or would it impose undue burdens on the industry? Would including the four key factors simplify compliance with the rules by making the content of this notice more similar to the content of the credit score notice for loans secured by residential real property?
- The Agencies solicit comment on the design and content of the proposed model forms. Do the proposed model forms and the accompanying instructions provide creditors with an appropriate degree of flexibility to change the forms without losing the compliance safe harbor?
- The Agencies solicit comment on all aspects of the proposal, particularly on the methods contained in the proposal that creditors may use to identify which consumers must receive risk-based pricing notices, and the approach of providing creditors with several options for complying with the rules. The Agencies also solicit comment on any other operationally feasible tests or approaches that would enable creditors to distinguish consumers who must receive notices from consumers who should not receive notices. The Agencies also solicit comment on the appropriateness of the proposed exceptions, and whether any additional or different exceptions should be adopted.
- Other comments?
Eric Richard General Counsel (202) 508-6742 firstname.lastname@example.org |
Mary Mitchell Dunn SVP & Deputy General Counsel (202) 508-6736 email@example.com
Jeffrey Bloch Assistant General Counsel (202) 508-6732 firstname.lastname@example.org
Lilly Thomas Assistant General Counsel (202) 508-6733 email@example.com
Luke Martone Senior Regulatory Counsel (202) 508-6743 firstname.lastname@example.org