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Fed Orders Lenders to Provide Borrowers with Risk-Based Notices

By Sally Maison
Published: Friday, January 1st, 2010

Consumers who get unfavorable terms on their car, mortgage, or card loans because of their credit report will now understand their plight better as the Federal Reserve and the Federal Trade Commission sent a letter this week to lenders requiring them to provide borrowers with “risk-based pricing” notices. This means that consumers will be informed what negative items on their credit report caused them to have higher interest rates and will be able to track what caused their credit problems.

Fed Orders Lenders to Provide Borrowers with Risk-Based Notices    Aside from helping them understand the lenders’ decision, risk-based pricing will also allow consumers to have a free access to their credit report. Federal officials say this new rule will enable consumers to easily correct credit report errors without costing them a lot of money.

As a general explanation to this rule, the Fed says creditors must provide a person with the notice if his annual percentage rate increase is caused, in whole or in part, by information in his credit report. Risked-based pricing is a term used by creditors such as banks, department stores, and financial institutions to determine interest rates they will charge a borrower based on his likelihood of defaulting on a loan. This can be determined by a borrower’s payment records, which is contained in his credit report.

To determine the probability of defaulting, creditors also look into other factors aside from payment history. A lender would pull out a potential borrower’s credit report to see how much debt he owes, how many lines of credit he currently has, and how many new accounts he has opened.

Lenders would then compare information on a credit report to the performance of other consumers who have similar records.  Some creditors use their own risk-scoring system, but they generally adopt the system of major credit bureaus. Experian employs the Experian/Fair Isaac risk system, Equifax uses the BEACON system, while TransUnion has the classic FICO Risk Score System.

In addition to this new rule, creditors will be required to inform a consumer if they use his credit report to extend credit for “personal, family, or household purposes.” Also, creditors must provide a notice if they offer less favorable terms to some borrowers while giving better terms to a bigger portion of consumers.

Lenders who cannot provide risk-based notices are given the option to give their potential borrowers a free access to their credit score and information about their rating.
Consumers are guaranteed with a free credit report once a year under federal law, but they are not entitled to a free access to their score.

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