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Fair Credit Reporting Risk-Based Pricing Regulations

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  1. Fair Credit Reporting Risk-Based Pricing Regulations Federal Reserve Board’s Regulation V

  2. Risk-Based Pricing When creditors offer more favorable terms to consumers with good credit histories and less favorable terms to consumers with poor credit histories.

  3. Background • FACT Act of 2003 signed on 12-04-2003. • Section 615(h) required risk-based pricing notice. • Proposed rules were issued 05-19-2008. • Final rules were issued on 12-22-2009. • Final rules are effective on 01-01-2011.

  4. Purpose • Risk-based pricing notice is designed to improve accuracy of consumer reports by alerting consumers to existence of negative information on their reports. • Once alerted to the existence of negative information, consumers can check their reports for accuracy and correct any inaccurate information. • Notice is intended to complement existing adverse action notice framework.

  5. Implementation Issues • Banks are given a menu of approaches that can be used to comply with the statute’s legal requirements. • Rules apply only to credit for personal, family, or household purposes. • Rules do not apply to consumer leases. • Rules do not apply to guarantors, co-signer, sureties, or endorsers.

  6. Overview A person must provide a risk-based pricing notice to a consumer… • when the person uses a consumer report in connection with an application, and • based on that consumer report, provides credit to that consumer on material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers from or through that creditor. *Notice is also required if APR is increased after origination because of information contained in a credit report, unless the creditor provides an adverse action notice.

  7. Material Term • For credit that has an APR, the material term is the APR. • For credit that does not have an APR, the material term is the financial term… • that the creditor varies based on the consumer report, and • that has the most significant financial impact on consumers (such as an annual membership fee or deposit).

  8. Materially Less Favorable The terms granted or extended to a consumer differ from the terms granted or extended to another consumer from or though the same person such that the cost of credit to the first consumer would be significantly greater that the cost of credit to the other consumer.

  9. Options for Determining Materially Less Favorable • Case-by-Case Review • Credit Score Proxy Method • Tiered Pricing Method • Credit Card Issuer Option

  10. Case-By-Case The creditor may determine, on a case-by-case basis, whether a consumer has received material terms that are materially less favorable than terms other consumers have received from or through that creditor by comparing the material terms offered to the consumer to the material terms offered to other consumers for a specific type of credit offered

  11. Credit Score Proxy Method Creditors that use credit scores to set material terms of credit can determine a cutoff score. This cutoff can be… • point at which 40% of consumers have higher credit scores and 60% have lower credit scores, or • if more than 40% have received credit at most favorable terms, then the percentage point at which consumers who historically have been granted credit on material terms other than the most favorable terms.

  12. Tiered Pricing Method A creditor that sets the material terms of credit by assigning each consumer to one of a discrete number of pricing tiers, based on a consumer report, may provide a risk-based pricing notice to each consumer who is not assigned to the top pricing tier or tiers.

  13. Credit Card Issuer Option Credit card issuer can provide a risk-based pricing notice to a consumer if the consumer applies for a credit card in connection with a multiple-rate offer and, based a consumer report, is granted credit at an APR that is higher than the lowest APR available under that offer.

  14. Credit Score Disclosure Exceptions Instead of issuing a risk-based pricing notice to just those consumers offered credit on “materially less favorable” terms, the creditor can provide all consumers who apply for credit with a notice consisting of their credit score and certain additional information.

  15. Other Exceptions • Applications where consumer applies for and receives specific material terms. • Applications where consumer has been or will be provided a notice of adverse action under section 615(a) of FCRA in connection with the transaction. • Prescreened solicitations involving firm offers of credit.

  16. Timing of Notice • Closed-End Credit: At or after approval decision is communicated but before consumer becomes contractually obligated. • Open-End Credit: At or after approval decision is communicated but before the 1st transaction. • Account Reviews: • If advance notice of APR change is required: At the time the APR increase is communicated to the consumer • If no advance notice of APR is required: No later than 5 days after effective date of the change. • Automobile Transactions: Special Rules • Instant Credit Transactions: Special Rules

  17. Who Provides the Notice? The person to whom the loan is initially payable must provide the risk-based pricing notice (or satisfy an exception). This is the case even if… • the loan is assigned to a third party, or • the person to whom the loan is initially payable is not funding the loan. Note: Although legal responsibility rests with party to whom obligation is initially payable, parties may determine by contract who will send notice.

  18. Multiple Consumers • Risk-based pricing notice: If a transaction involves two or more consumers… • At same address, a single notice addressed to both consumers will suffice. • Not at same address, each consumer must receive a notice. • Credit score disclosure notice: If a transaction involves two or more consumers, each consumer must be provided an individualized notice.

  19. Free Credit Report • A consumer who receives a risk-based pricing notice has a right to a separate free consumer report upon receipt of a risk-based pricing notice. • The notices provided under the credit score disclosure exception are not risk-based pricing notices and do not give rise to the right to receive a free credit report.

  20. Definitions

  21. Previously Defined Definitions • The following terms have the same definition in Regulation V as they do in Regulation Z: • annual percentage rate • closed-end credit • open-end credit plan • consummation • The following terms are defined using FCRA’s statutory definitions: • credit • creditor • credit card • credit card issuer • credit score

  22. Material Terms – Open End Credit (Except Credit Cards) The APR that is the material term should exclude… • any temporary initial rate that is lower than the rate that will apply after the temporary rate expires, • any penalty rate that will apply upon the occurrence of one or more specific events (such as a late payment or an extension of credit that exceeds the credit limit), and • any fixed APR option for a home equity line of credit.

  23. Material Terms – Credit Card The APR that is the material term should be… • For credit cards with a purchase APR, the APR that applies to purchases (“Purchase APR”). • For credit cards with no purchase APR: the APR that varies based on information in a consumer report and that has the most significant financial impact on consumers. Note: Open-end rules regarding exclusion of temporary initial rate and penalty rates are also applicable to calculation of purchase APR.

  24. Material Terms – Closed-End Credit The APR that is the material term should be the APR disclosed in Regulation Z disclosures prior to consummation. Note: This definition did not address temporary initial rates or penalty rates because, for purposes of the closed-end provisions of Regulation Z, a penalty rate is not included in the calculation of the APR and a temporary initial rate is but one component of a single AOR for the transaction.

  25. Material Terms – Credit with no APR The financial term that varies based on information in a consumer report and that has the most significant financial impact on consumers, such as a deposit required in connection with credit extended by a telephone company or a utility or an annual membership fee for a charge card.

  26. Materially Less Favorable The terms provided to a consumer differ from the terms provided to another consumer from or through the same person such that the cost of credit to the first consumer would be significantly greater than the cost of credit to the other consumer. Factors relevant to determining the significance of a difference in cost include… • the type of credit product, • the term of the credit extension, if any, • and the extent of the difference between the material terms provided to the two consumers.

  27. The Rules Who Must Receive a Risk-Based Pricing Notice

  28. General Rule A person must provide a risk-based pricing notice if the person – • uses a consumer report in connection with an application for, or a grant, extension, or other provision of, credit to that consumer; AND • based in whole or in part on the consumer report, grants, extends, or otherwise provides credit to that consumer on material terms that are materially less favorable that the most favorable material terms available to a substantial proportion of consumers from or through that person.

  29. Case-by-Case Method Bank can directly compare the material terms offered to each consumer and the material terms offered to other consumers for a specific type of product. • “Specific type of product” means one or more credit products with similar features that are designed for similar purposes. Examples include student loans, unsecured credit cards, secured credit cards, new automobile loans, used automobile loans, fixed-rate mortgage loans, and variable rate mortgage loans.

  30. Steps in a Case-by-Case Method • Identify the appropriate subset of current or past consumers to compare to any given consumer. (This subset would need to be an adequate sample of consumers who have applied for a specific type of credit product.) • Compare the material terms. (But creditor would need to disregard any underwriting criteria that do not depend upon consumer report information).

  31. Alternatives to Case-by-Case Method • Credit Score Proxy Method • Tiered Pricing Method • Credit Card Issuer Option Note: For purposes of consistency, a person must use the same method to evaluate all consumers who are granted, extended, or otherwise provided a “specific type of product” from or though that person.

  32. Credit Score Proxy– General Rule A creditor that uses credit scores to set material terms of credit can… • determine the score that represents the point at which approximately 40% of its consumers have higher credit scores and approximately 60% of its consumers have lower credit scores, and • provide a risk-based pricing notice to each consumer with a credit score below that cutoff score.

  33. Credit Score Proxy – General RuleExample A person extended credit to 10,000 consumers. It determines that 40% of those consumers (or 4,000 consumers) had credit scores of 700 or higher. That person would use 400 as its cutoff score. If a consumer was approved for credit with a score of 699 or lower, that consumer would need to be provided a risk-based pricing notice.

  34. Credit Score Proxy – AlternativeSampling Method If a person finds that more than 40% of its customers have received credit at the most favorable terms, that person can… • determine the point at which some percentage of its customers have historically been given credit on material terms other than the most favorable terms, • determine the score that represents that point, and • provide a risk-based pricing notice to each consumer with a credit score below that cutoff score.

  35. Credit Score Proxy - Alternative Sampling Method Example A credit card issuer takes a representative sample of consumers to whom it provided credit* over the preceding six months. • Determines that 80% received credit at the lowest available APR (most favorable term). • Determines that those 80% of customers have a score at or above 750. • Sets 750 at its cutoff score. • Provides risk-based pricing notice to consumers with credit scores below 750. *Correct universe is consumers to whom the person has provided credit.”

  36. Credit Score Proxy – AlternativeSampling Method - Special Rules A person is permitted, but not required, to use the alternative approach when more than 60% of its customers receive credit at other than the most favorable terms. BUT A person may not use the alternative approach when fewer than 40% of its customers receive credit at the most favorable terms.

  37. Credit Score Proxy - Alternative When No History Available • When a person is new to credit business, introduces new credit products, or just starts to use risk-based pricing, it can determine a credit score cutoff based on information from market research of relevant third party sources for the specific type of credit product. • When a person acquires a credit portfolio as a result of a merger or acquisition, it can determine the cutoff score based on information from the party which acquired, with which it merged or from which it acquired the portfolio.

  38. Credit Score Proxy – AlternativeRecalculation of Cutoff Score Sampling Method: • Person using the sampling approach must recalculate its cutoff score at least every 2 years. No History Available: • Person relying on third party information must recalculate its cutoff score within 1 year based on its own consumers’ information. • If a person does not provide credit to new consumers during the 1-year period, it can continue to use third party information until it obtains sufficient data (but no longer than 2 years).

  39. Credit Score Proxy – AlternativeUse of Multiple Credit Scores If a person uses more than one credit score to set the material terms of credit, must determine the cutoff score using the same method the person uses to evaluate multiple scores when making a credit decision.

  40. Credit Score Proxy – AlternativeMultiple Credit Scores (Examples) Example #1: If a person uses the average of two scores when setting the material terms of credit, then… • that person must use the average of its consumers’ scores when calculating the cutoff scores. Example #2: If a person uses the lower of two scores when setting the material terms of credit, then… • that person must use the lower of its consumers’ scores when calculating the cutoff score.

  41. Credit Score Proxy – AlternativeMultiple Credit Scores (Safeharbor) When a person that uses multiple credit scores does not consistently use the same method to evaluate multiple scores, the person must calculate the cutoff score using a reasonable means. This is defined as… • any one of the methods the person regularly uses or • (b) the average credit score of each consumer to whom it provides credit.

  42. Credit Score ProxyCredit Score Not Available A person using the credit score proxy method (pursuant to the general rule or the alternative rule) that provides credit to a consumer with no credit score must … • assume the consumer receives credit on other than the most favorable material terms, and • provide a risk-based pricing notice to the consumer.

  43. Alternatives to Case-by-Case Method • Credit Score Proxy Method • Tiered Pricing Method • Credit Card Issuer Option Note: For purposes of consistency, a person must use the same method to evaluate all consumers who are granted, extended, or otherwise provided a “specific type of product” from or though that person.

  44. Tiered Pricing Method The tiered pricing method can be used by a person that sets the material terms of credit provided to a consumer by placing the consumer within one of a discrete number of pricing tiers based, in whole or in part, on information in a consumer report.

  45. Tiered Pricing MethodFour or Fewer Pricing Tiers A person must provide a risk-based pricing notice to each consumer who does not qualify for the top tier (i.e., the lowest priced tier). Example: A person uses a tiered pricing structure with APRs of 8, 10, 12, and 14 percent. It would be required to provide a risk-based pricing notice to each consumer to whom it provides credit at 10, 12, and 14 percent.

  46. Tiered Pricing MethodFive or More Pricing Tiers A person must provide a risk-based pricing notice to each consumer who does not qualify for… • the top two tiers (i.e., the two lowest priced tiers), AND • any other tier that together with the top two tiers comprise no less than the top 30% but no more than the top 40% of the total number of tiers.

  47. Tiered Pricing MethodFive or More Pricing Tiers (Example) Question: A person has 9 pricing tiers. Consumers in which tiers should receive a pricing notice? Answer: The bottom six tiers. Risk-based pricing notices are never needed for the top two tiers. And, in this case, the third tier must be added to the top two tiers create a top set of tiers that captures at least 30% but no more than 40% of the total number of tiers.

  48. Alternatives to Case-by-Case Method • Credit Score Proxy Method • Tiered Pricing Method • Credit Card Issuer Option Note: For purposes of consistency, a person must use the same method to evaluate all consumers who are granted, extended, or otherwise provided a “specific type of product” from or though that person.

  49. Credit Card Issuers Credit card issuers may… • select the case-by-case method, • select the special credit card issuer option, or • select the credit score proxy method or the tiered pricing method.

  50. Credit Card Issuer Option A credit card issuer may provide a risk-based pricing notice when… • a consumer applies for credit with more than one possible purchase APR, and • that consumer receives a credit card with a purchase APR that is greater than the lowest purchase APR available in connection with the application or solicitation pursuant to which credit is extended.