Re: What is the Risk-based pricing?

RobertEG — Sun, 14 Apr 2013 00:41:47 GMT

When you apply for credit, there are two broad categories of applications.

The first is where the consumer applies without having received a firm (pre-approved) offer, and the second is in response to such a firm offer.

Firm offers are usually those that result from the creditor obtaining your name and address from a CRA, for which a consumer can "op-out" of being on such CRA lists, and thus discontinue such promotional offers for credit. FCRA 603(l) defines a firm offer for credit as one that will be honored if the consumer is determined, based on information in their credit report to meet the specific criteria used to select the consumer for the offer.

Next comes the creditor's consideration of the consumer's application.

If their determination is a complete denail of credit, that is considered an "adverse action" on their part, and gives rise to the consumer's right to obtain a free copy of the CR used by the creditor. I wont go into details, which are covered in FCRA 615(a), as such denials are distinguished from the question of risk-based pricing, which is when the credttor makes a counter-offer at less favorable terms.

The question posed, "risk-based pricing", relates to situations where the creditor reviews the consumer's credit report, and counter-offers at terms less favorable to either their most favorable terms or the terms offered in their firm offer for credit, and if their assessment of the consumer's risk is based in any part on information in their credit report. Their pricing of the credit is thus increased due to perceived consumer risk.

That kicks in the requirement by the creditor to provide a formal Notice of Risk-based Pricing, as detailed in regs published under FCRA 615(h),

In broad-brush, they must provide a notice that includes a statement that terms being offered are set based on information in their consumer report, identity the name of the CRA who furnished them the consumer report, and advise the consumer that they may obtain a free copy of their credit report from that CRA.

The FTC has published a formal rule providing the basic content of a risk-based pricing notice. Below is the notice published by the FTC when the rules were implemented, along with a cite to the full rules.

The FACT Act’s Risk-Based Pricing

Final Rules

Effective January 1, 2011

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

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;

•

A statement that the consumer is encouraged to verify the accuracy of the

information contained in the credit report and has the right to dispute any

inaccurate information in the report;

•

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

of a consumer report, without charge for 60 days after receipt of the

notice, from the consumer reporting agency identified in the notice.

•

A statement informing the consumer how to obtain a consumer report from

the consumer reporting agency or agencies and providing contact

information specified by the reporting agencies; and

•

A statement directing consumers to the web sites of the Federal Reserve

Board and Federal Trade Commission to obtain more information about

consumer reports.

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;

•

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.

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;

•

A statement that the consumer is encouraged to verify the accuracy of the

information contained in the credit report and has the right to dispute any

inaccurate information in the report;

•

A statement that federal law gives the consumer the right to obtain a copy

of a consumer report, without charge for 60 days after receipt of the

notice, from the consumer reporting agency identified in the notice.

•

A statement informing the consumer how to obtain a consumer report from

the consumer reporting agency or agencies and providing contact

information specified by the reporting agencies; and

•

A statement directing consumers to the web sites of the Federal Reserve

Board and Federal Trade Commission to obtain more information about

consumer reports.

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 the consumer is encouraged to verify the accuracy of the

information contained in the credit report and has the right to dispute any

inaccurate information in the report;

•

A statement that federal law gives the consumer the right to obtain a copy

of a consumer report, without charge for 60 days after receipt of the

notice, from the consumer reporting agency identified in the notice.

•

A statement informing the consumer how to obtain a consumer report from

the consumer reporting agency or agencies and providing contact

information specified by the reporting agencies; and

•

A statement directing consumers to the web sites of the Federal Reserve

Board and Federal Trade Commission to obtain more information about

consumer reports.

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 the consumer is encouraged to verify the accuracy of the

information contained in the credit report and has the right to dispute any

inaccurate information in the report;

•

A statement that federal law gives the consumer the right to obtain a copy

of a consumer report, without charge for 60 days after receipt of the

notice, from the consumer reporting agency identified in the notice.

•

A statement informing the consumer how to obtain a consumer report from

the consumer reporting agency or agencies and providing contact

information specified by the reporting agencies; and

•

A statement directing consumers to the web sites of the Federal Reserve

Board and Federal Trade Commission to obtain more information about

consumer reports.

A copy of the final rules can be found here

http://www2.ftc.gov/os/2009/12/R411009riskbasedpricingfrn.pdf

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