The FACT Act s Risk-Based Pricing Final Rules

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1 Effective January 1, 2011 The FACT Act s Risk-Based Pricing Final Rules Under the new section 615(h) of FCRA, a risk-based pricing notice must be provided when a consumer report is used in connection with providing credit with materially less favorable terms than the most favorable terms available to a substantial proportion of customers. In a transaction involving more than one consumer, a risk-based pricing notice must be provided to each consumer. Additionally, if a creditor conducts a periodic account review and increases a consumer s annual percentage rate because of a deteriorated credit report, the creditor must provide either a risk-based pricing/account review notice or adverse action notice to the consumer. The risk-based pricing notice rules apply only in connection with credit that is primarily for personal, household, or family purposes, but not with business credit or consumer lease transactions. Determining Which Consumers Receive a Notice Determining whether a consumer received material terms that are materially less favorable than terms other consumers have received may be determined on a case-by-case basis by comparing material terms offered to the consumer to the material terms offered to other consumers for the same type of credit product. In most cases, the term material terms is defined with reference to the annual percentage rate. For credit cards, the annual percentage rate used for purchases, excluding any temporary initial rates and penalty rates would be the material term. For credit with no annual percentage rate, material terms is defined as the financial term that varies based on information in a consumer report and that has the most significant financial impact on consumers. The final rules provide two alternative methods for determining which consumers must receive risk-based pricing notices. The first method is the credit score proxy method. A creditor using a credit score to set the material terms of credit may determine a cutoff score representing the point at which approximately 40 percent of its consumers have higher credit scores and 60 percent of its consumers have lower credit scores, and provide a risk-based pricing notice to each consumer who has a credit score lower than the cutoff score. These creditors must recalculate their cutoff scores at least every two years. Because this method would require creditors to use a sampling approach, the final rule permits some creditors that have not developed a representative sample of consumers, such as new entrants to the credit business, to new credit products or to risk-based pricing, to determine the appropriate cutoff score based on information from appropriate market research or relevant third-party sources for similar products. If these creditors have granted credit to some new consumers 1

2 within two years, the creditor must recalculate the cutoff score using the sampling approach. The second method is the tiered pricing method. Under this method, a creditor that sets the material terms of credit by assigning each consumer to one of a discrete number of pricing tiers may use this method and provide a risk-based pricing notice to each consumer who is not assigned to the top pricing tier or tiers. Specifically, where there are four or fewer pricing tiers, a person must provide a risk-based pricing notice to each consumer who does not qualify for the top tier. Where there are five or more pricing tiers, a risk-based pricing notice must be sent to each consumer who does not qualify for the top two tiers, plus any other tier that represents at least the top 30%, but no more than the top 40% of the total number of tiers. As an alternative to the two methods described above, a special test for credit card issuers may be used. If a consumer applies for a credit card in connection with a multiple-rate offer and is granted credit at an annual percentage rate higher than the lowest annual percentage rate available under that offer, the issuer is required to provide a risk-based pricing notice. If a creditor conducts an review of credit that has been extended to a consumer and increases the annual percentage rate as a result of information on a consumer report, the creditor must provide a risk-based pricing notice. Content and Form of the Notice The final rules provide several model forms that may be used in complying with these rules. Two of the model forms are for the risk-based pricing notices and three model forms are for the credit score disclosure exception. The risk-based pricing notice must contain: A statement that a credit report includes information about the consumer s credit history and the type of information included in that history; A statement that the terms offered, such as the annual percentage rate, have been set based on information from a consumer report; A statement that the terms offered may be less favorable than the terms offered to consumers with better credit histories; The identity of each consumer reporting agency that furnished a credit report used in the credit decision; A statement that federal law gives the consumer the right to obtain a copy 2

3 A statement informing the consumer how to obtain a consumer report from If a creditor conducts an account review and must provide a risk-based pricing notice as a result of an increased annual percentage rate, the notice must also include a statement that the creditor conducted a review of the account using information from a credit report and that as a result of the review, the APR has been increased based on information from a consumer report. The notices must be clear and conspicuous and can be provided in oral, written, or electronic form. Additionally, a safe harbor is provided when the model forms are used. The notice must be provided after the terms of credit have been set, but before the consumer becomes contractually obligated on the credit transaction. For closed-end credit, the notice must be provided before consummation of the transaction, but not earlier than the time the approval decision is communicated to the consumer. For open-end credit, the notice must be provided before the first transaction is made, but not earlier than he time the approval decision is communicated to the consumer. For account reviews, the notice must be provided at the time the decision to increase the APR is communicated. If no notice of the increased APR is provided before the effective date of the change, the risk-based pricing notice must be provided no later than five days after the effective date of the APR change. For indirect auto lending, the requirement to provide a risk-based pricing notice is satisfied if the auto dealer provides a notice to the consumer on the creditor s behalf within the required time periods and the creditor maintains reasonable policies and procedures to verify that the auto dealer provides the notice within the applicable time periods. For contemporaneous purchase credit (instant credit), the notice may be provided at the earlier of either the time of the first mailing after approval or within 30 days after approval. This only applies to instant credit granted in person or on the telephone and does not apply to online contemporaneous purchase credit transactions. Exceptions to the Risk Based Pricing Notice Requirements When a consumer applies for and receives specific material terms; When a consumer is provided an adverse action notice; 3

4 When a creditor obtains a consumer report that is a prescreened list and uses that consumer report to make a firm offer of credit to consumers. When an extension of credit is or will be secured by one to four units of residential real property and the consumer is provided a notice consisting of his credit score and certain additional information in lieu of the riskbased pricing notice. o In a transaction involving two or more consumers, a separate notice must be provided to each consumer and must contain only the credit score of the consumer to whom the notice is provided, and not the credit score of the other consumer; When a consumer is provided the required credit score disclosure and certain additional information that provides context for the credit score disclosure; When a credit score is not available from the agency from which the creditor regularly obtains a score and the creditor does not obtain a credit score from another consumer reporting agency and provides a consumer a notice that contains certain information. Credit Score Disclosure Exception for Credit Secured by One to Four Units of Residential Real Property. This exception would permit creditors offering loans to consumers that are secured by one to four units of residential real property to comply with the rules by adding certain supplemental disclosures regarding the use of consumer reports to the credit score disclosure they already are required to provide to consumers under FCRA. This integrated notice could be provided to any consumer who requested credit in connection with loans secured by real property and would not be required to compare the terms offered to different consumers. This integrated notice must include: A statement that a credit 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 statement that 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; A statement that a consumer s credit score can affect whether the consumer can obtain credit and what the cost of that credit will be; The information required to be disclosed under the Fair Credit Reporting Act; The distribution of credit scores among consumers who are scored under the same scoring model, presented either in the form of a bar graph or other graphical means or in a narrative statement; 4

5 A statement that federal law gives the consumer the right to obtain a copy A statement informing the consumer how to obtain a consumer report from Credit Score Disclosure Exception for Other Extensions of Credit This exception is provided when a consumer is given the required credit score disclosure and certain additional information that provides context for the credit score disclosure. A risk-based pricing notice is not required when a consumer requests an extension of credit and the creditor provides a notice that contains: A statement that a credit 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 statement that 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; A statement that a consumer s credit score can affect whether the consumer can obtain credit and what the cost of that credit will be; The consumer s current credit score or the most recent score that was calculated by the consumer reporting agency for purposes of the extension of credit; The range of possible credit scores under the model used to generate the credit score; The distribution of credit scores among consumers who are scored under the same scoring model, presented either in the form of a bar graph or other graphical means or in a narrative statement; The date on which the credit score was created; The name of the consumer reporting agency that provided the score; A statement that federal law gives the consumer the right to obtain a copy A statement informing the consumer how to obtain a consumer report from 5

6 Exception When Credit Score Not Available A creditor does not need to provide a risk-based notice if a credit score is not available from the consumer reporting agency from which the creditor regularly obtains credit scores and the creditor does not obtain a credit score from another agency as long as the creditor provides a notice containing the following: A statement that a credit 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 statement that 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; A statement that a consumer s credit score is important because consumers with higher credit scores generally obtain more favorable credit terms; A statement that not having a credit score can affect whether the consumer can obtain credit and what the cost of that credit will be; A statement that a credit score about the consumer was not available from a consumer reporting agency, which must be identified by name, generally due to insufficient information regarding the consumer s credit history; A statement that federal law gives the consumer the right to obtain a copy A statement informing the consumer how to obtain a consumer report from A copy of the final rules can be found here 6