The requirements for risk-based pricing notices and credit score exception notice (i.e credit score disclosure)can be extremely confusing at times. Trust me, I know. As was the case for me in the past, most bankers don’t have to worry about understanding the different disclosure options available as a bank will only use one form or another and will never have a need for the other disclosure options. That said, however, understanding which disclosures are required is important to ensure proper disclosures are being provided to loan applicants.
Let’s begin by discussing the risk-based-pricing notice.
In 2003, the FACT Act started the ball rolling on the 2011 rules found in section 1022.73 of Regulation V which affect financial institutions who offer risk-based pricing. Risk-based pricing is when a creditor sets a rate (or other credit terms) based on a consumer’s risk of non-payment. Basically, rates are higher for those with a low credit score while the best rates are only available to those with a good credit history. The language in the rule talks about when “less favorable” terms are given to those with poor credit history.
Determining who receives “less favorable” terms can actually be quite complex and is probably a discussion for another day. That said, there are generally two ways to determine “less favorable” terms: 1) The credit score proxy method and 2) the tiered pricing method. I don’t want to spend any time on these two options, as most are able to get around the rule, which I will explain in a little bit.
Now, institutions that offer risk-based pricing have additional disclosure requirements in section 1022.73 of Regulation V where they must provide a “risk-based pricing notice” to certain customers. There are 4 different risk-based-pricing model forms that could be used, all found in Appendix H of Regulation V:
Model form H–1 is for use in complying with the general risk-based pricing notice requirements in Regulation V if a credit score is not used in setting the material terms of credit.
Model form H–2 is for risk-based pricing notices given in connection with account review if a credit score is not used in increasing the annual percentage rate.
Model form H–6 is for use in complying with the general risk-based pricing notice requirements in Sec. 1022.72 if a credit score is used in setting the material terms of credit.
Model form H–7 is for risk-based pricing notices given in connection with account review if a credit score is used in increasing the annual percentage rate.
While this may seem fairly straightforward, it is actually fairly difficult to comply as we have to differentiate between those customers that had “less favorable” terms and then provide the notices accordingly. Fortunately for us, the final rule didn’t end up this difficult.
One thing we have to understand about the risk-based-pricing rule is that congress made a very difficult requirement and the Federal Reserve wrote the rule in a way that is much easier – which essentially helps financial institutions get around the rule. This occurs in section 1022.74 of Regulation V, which discusses exceptions to the risk-based-pricing disclosure. This section essentially provides 6 exceptions to the risk-based-pricing notice:
Application for Specific Terms: In short, when a consumer receives terms they applied for, the risk-based-pricing notice is not required.
Adverse Action Notice: If an adverse action notice containing FCRA information is provided to a customer, a risk-based pricing notice is not also needed.
Prescreened Solicitations: A risk-based pricing notice is not needed when a creditor solicits a firm offer of credit.
Loans Secured by Residential Real Estate: The risk-based pricing notice can be avoided if 1) the loan is secured by one to four units of residential real property and 2) if a credit score exception notice is provided to all consumers applying for credit secured by one to four units of residential real estate.
Other Extensions of Credit – Credit Score Disclosure: The risk-based pricing notice can be avoided on if 1) the loan is not secured by one to four units of residential real property and 2) if a credit score exception notice is provided to all consumers applying for similar credit.
Credit Score Not Available: The risk-based pricing notice is not needed if 1) a credit score is not available, 2) a credit score is not obtained from another consumer reporting agency, and 3) a credit score exception notice is provided to the applicant.
Based on these exceptions, Appendix H provides three different model forms:
- Model form H–3 is for use in connection with the credit score disclosure exception for loans secured by residential real property.
- Model form H–4 is for use in connection with the credit score disclosure exception for loans that are not secured by residential real property.
- Model form H–5 is for use in connection with the credit score disclosure exception when no credit score is available for a consumer.
So, to summarize this, the risk-based pricing notice is not required if a credit score exception disclosure (forms H-3, H-4, or H-5) is provided. In short, most financial institutions essentially get around the risk-based-pricing rule by providing a credit score exception notice to everyone.
While this information is helpful for financial institutions that have risk-based pricing, we need to also look at the requirements for those FIs that don’t have risk-based pricing.
If a financial institution does not utilize risk-based pricing, it is important to note that there are still disclosure requirements for mortgage loans. The Fair Credit Reporting Act (FCRA) outlines rules in section 609(g) that require a notice to home loan applicant. Specifically, this rule requires anyone who makes loans and uses a consumer credit score in connection with a loan application (open-end or closed-end) initiated by a consumer for a consumer purpose that is secured by 1 to 4 units of residential real property must provide 1) disclosures required in subsection f (disclosures of credit scores) and 2) a notice to home loan applicants.
In short, this is a disclosures that includes things like the credit score of the applicant, the range of possible scores, key factors that adversely affected the credit score, the date of the score, and the name of the person or entity that provided the score.
So, how is this information delivered? By using the H-3 disclosure.
The pre-amble to the 2010 ruling states the following: “Appropriate use of model form H-3 or model form B-3 is also intended to be compliant with the disclosure that may be required under section 609(g) of the FCRA.
That full rule can be found here: https://www.federalregister.gov/documents/2010/01/15/E9-30678/fair-credit-reporting-risk-based-pricing-regulations
