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Changes to the Credit Reporting Act.

Credit report information is rapidly becoming the linchpin upon which lenders base loan decisions. As this data becomes more crucial, it is more important than ever that the law governing it preserves the accuracy of the data. Amendments to the federal law on fair credit reporting are a step in the right direction.

Significant changes to the fair credit reporting Act (FCRA) enacted last September will have longterm effects on the mortgage industry. While most mortgage industry professionals were aware of these changes, the impact on credit information quality and the cost to mortgage lenders has yet to be realized. Many are still implementing the changes to internal systems to meet new standards set by the 1997 amendments to the FCRA.

These amendments are significant refinements and by and large are positive changes. But they place additional demands on the repositories, mortgage credit reporting agencies and lenders that will require additional costs to comply. This article gives an overview of the amendments and the significance of these changes to the mortgage industry.

Credit reporting agencies changed many of their procedures before the enactment of the Fair Credit Reporting Act amendments on September 30, 1997, and have made other changes since the statutory revisions took effect. The amendments put a spotlight on the accuracy of credit reports, a critical factor as credit scoring becomes much more common in the loan-approval process.

Credit scoring is becoming more important as the lending industry tries to limit risk while increasing efficiencies. Freddie Mac and Fannie Mae as well as many lenders are looking more closely at the opportunities offered by risk-based pricing. This makes it more crucial than ever to ensure that credit reports are based on absolutely accurate and up-to-date information.

The amendments themselves, though enacted last fall, had been discussed in Congress since 1989, says Norm Magnuson, director of public affairs, Associated Credit Bureaus (ACB), Washington, D.C. "We didn't just wake up on October 1 to find a new law in place," Magnuson says. "The industry has been working on credit reporting improvements for several years."

Enacting the amendments will lead to further improvements in credit reporting accuracy by the major credit repositories. Magnuson and other industry experts point out that the FCRA amendments impose requirements on others outside the credit repositories.

To better understand the potential effects of the amendments, it's important to look at them in a historical context.

History of the FCRA

The Fair Credit Reporting Act was originally enacted by Congress in 1970 to codify the rules regarding how credit information is gathered, disseminated and used, thereby setting a national standard. The FCRA was intended to protect consumer rights and help eliminate spurious and devious practices in the collection and use of credit information and in credit-granting. It gives credit reporting agencies and grantors of credit more standardized procedures for how credit information is reported, used and accessed.

Before the amendments, the FCRA carried no civil or criminal penalties for violations. Now the Federal Trade Commission (FTC) can fine credit reporting agencies and furnishers of credit details for the misuse of credit information, although the FTC's jurisdiction is not always clear. If a consumer has a complaint against a financial institution that allegedly filed erroneous information, that institution might be subject to fines from the appropriate banking regulator, such as the Federal Deposit Insurance Corporation (FDIC), the Office of Thrift Supervision (OTS) or the Credit Union National Association, rather than the FTC.

Credit reporting agencies include many types of databases - credit bureaus, tenant-screening companies, check-verification services, for example. Credit reporting agencies themselves have been working to improve the quality of their credit reports for some time, says Maxine Sweet, vice president of consumer education for Experian of Orange, California. But the law could force some of the smaller furnishers of credit information to keep a more watchful eye on their reporting habits. The FTC has yet to make public any fines under the FCRA amendments and will not discuss any pending actions.

While he does not expect government agencies to be overzealous in enforcing the law, Magnuson expects to see announcements of violations in the first half of 1998. The amendments indicate that the government is taking a closer look at the credit reporting practices of credit reporting agencies and lenders alike - oversight that now carries the weight of possible fines behind it.

Credit file improvements

Magnuson doubts problems will be found at the credit repositories because of actions they took earlier in the decade to improve credit information and to resolve disputes by consumers over information reported on their credit reports. Experian launched a new relational database in June 1996, which the company says provides more accurate and complete credit reports with increased protection against fraud and privacy infringement.

The system uses unique personal identification numbers for internal use to locate all information about one particular customer. The company says this eliminated "mixed-file" problems where credit information about two consumers with the same or similar names and other identifying information are combined into one report. This was a common problem, particularly in the refinancing crunch earlier in the 1990s.

Experian's relational database helps more accurately match data to the correct consumer, even if the consumer uses variations of his or her name or there is a transposition of a Social Security number or a similar minor discrepancy. The database establishes a relationship among different data elements, which the company says is more accurate and flexible than the system Experian (formerly TRW) had used since 1971.

Before the amendments were even enacted, Experian, Chicago-based Trans Union and Atlanta-based Equifax already had made it easier for consumers to obtain reports so they could correct erroneous information. Experian started offering complimentary credit reports to consumers in April 1992, but ended the practice in January 1997, citing competitive disadvantages. Experian also cited lack of public insistence to have competitors provide complimentary credit report copies. During the nearly five-year period, Experian processed and mailed about 5 million free reports.

Among the disadvantages cited by Experian was the abuse of the reports by credit-repair companies, which referred clients to Experian for the free reports. These credit-repair companies, sometimes called credit-repair clinics, were probably the firms most affected by the recent changes in the law. Credit and consumer protection officials agree that the practices of these companies needed to be policed more closely by the FTC.

The companies can charge up to $8 for copies of credit reports, though some states require that they be provided at no charge. Reports can be requested via telephone or via the companies' Web sites. Trans Union changed its credit reports into a more understandable format a couple of years ago, making it easier for consumers to find and correct errors.

Higher expenses

These changes have meant that credit reports are more expensive to produce. Additional staff will be added to meet the new response requirements and better systems for handling consumer disputes have been developed. The credit industry as a whole in partnership with credit grantors across the country have invested in a national electronic information exchange to speed changes and corrections to consumer credit reports.

The repositories have yet to pass along any of this cost to the buyers of the information, but indicate that cost increases are under consideration when contracts are renewed. Increased costs at the repository level will ultimately be passed along to mortgage credit reporting companies and ultimately, mortgage lenders in the form of higher costs for mortgage credit reports.

Based on our experience at The Credit Network, an organization specializing in credit reporting services for the mortgage industry, credit reporting costs to mortgage lenders, on a per-loan basis, have decreased largely because of the increased use and popularity of merged repository credit reports. Merged reports are quicker to produce and are less expensive than the traditional residential mortgage credit report (RMCR).

Ironically, the rise in popularity of the merged repository report has made residential mortgage credit reports more expensive to produce. This has resulted from a growing trend of ordering RMCRs only when there appears to be a problem such as obvious errors in the merged report, credit items disputed by the borrower or conflicting information between the repositories that requires further investigation. This trend has driven the cost of RMCRs upward in order to meet secondary market requirements. William Shea, vice president of Credit Data Services in Springfield, Massachusetts, says, "Our average time and the work we do to complete a Residential Mortgage Credit Report has increased at least 25 percent."

Further improvement expected

Connie Ferran, director of marketing for Freddie Mac, says the corporation expects to see better quality reports as a result of the amendments, though Freddie Mac is just now looking into the quality of the reports generated since the enactment of the FCRA changes.

According to David Olson, president of Olson Research, Columbia, Maryland, the mixed-file cases might have been largely eliminated, but credit repository officials admit there is still room for improvement.

"It's our responsibility to live up to these expectations," Magnuson says. "That's what the market demands."

The responsibility for accurate information ultimately rests with the credit repositories, but officials from those companies, the FTC, Fannie Mae and Freddie Mac, suggest that anyone who furnishes or uses information should bear part of the responsibility, from the consumer on up.

The consumer should try to make sure the information in the report is accurate, Sweet advises. The sooner the consumer starts the dispute process, the sooner the information can be corrected.

"It's important to get the dialogue started," agrees William Calpin, vice president of Equifax Banking Solutions.

The new FCRA amendments shorten the amount of time the repositories have to respond to disputes by consumers over information contained in the credit file from 60 days to 30 days, a period that was included in the amendments. However, the repositories had already voluntarily adopted this response standard well before the legislation was enacted.

"The credit reports have been getting steadily better," says Olson. "However, watching improvements over a short time is sort of like watching paint dry."

Lenders should carefully go over applications and question items that seem incorrect. "It's the lender's responsibility to make sure the information they receive from the borrower is accurate," says Chip Coffay, Fannie Mae director of credit policy.

Though many actions were taken earlier to improve the quality of credit reports, the FCRA amendments have had an immediate impact on disreputable companies on the fringe of the credit reporting industry. The new amendments take direct aim at credit-repair clinics. They cannot receive fees for service in advance. As a result, users have the right to dispute their bill if services are not rendered. This will likely eliminate those clinics that cannot repair credit but take advantage of those consumers who do not know any better.

Sweet and others in the credit reporting industry agree that these credit clinics need better policing. The new law says these clinics must now provide written disclosure of a consumer's rights and a contract detailing what the clinic will do and how long it will take. The clinic may not charge the consumer for anything until the work has actually been completed.

The amendments redefine the section of the law that addresses "permissible purposes," in which specific allowable users for credit reports are listed. The amendments now allow the use of credit reports by insurance and investment organizations that have an interest in the credit-worthiness of an individual belonging to a pool of mortgages, i.e., Fannie Mae and Freddie Mac. This is to determine the credit-worthiness or the value of a portfolio based on individual credit within the pool.

Amendments to the FCRA now protect lenders and credit reporting agencies from frivolous lawsuits. If a plaintiff lawyer files a lawsuit that has no legal merit, the defendant (the lender or the credit reporting agency) can file counteraction for court fees, attorney's fees and other court-related costs.

The way consumer data is formatted also has changed, says Oscar Marquis, vice president and general counsel for Trans Union. Consumers also can request that they be removed from lists the credit repositories provide to lenders for prescreening purposes - a process known as opting out.

Another change is that the credit file will display the user of the credit information. Sometimes this information is resold two or three times before reaching the user, Sweet says. Additionally, mortgage brokers sometimes shop the loan application several times before finding a lender with which to work.

Credit-scoring changes

Lenders have long complained that multiple inquiries on credit reports have the effect of lowering credit scores for applicants who would otherwise meet underwriting criteria. The industry recognized this problem and has made corrections.

The Fair, Isaac & Co., Inc., San Rafael, California, recently changed its credit-scoring model so that multiple requests or inquiries made of the consumer credit report less than 30 days old will be treated as a single request. Additionally, multiple requests more than 30 days old will be treated as a single inquiry if they are made in a 14-day period, says Peter L. McCorkell, senior vice president and general counsel for Fair, Isaac. He expects the change to result in more accurate credit reports. McCorkell expects the credit repositories to be using the updated scoring model by the end of the first quarter. Some subprime lenders were already treating multiple reports as a single request.

Fannie Mae and Freddie Mac also update their automated underwriting systems periodically. Merged files are being used to handle most credit decisions today. Recent analyses of credit report usage at The Credit Network indicate that as much as 70 percent of mortgage loans funded in 1997 were underwritten using merged repository credit reports, showing a trend of continued growth. Freddie Mac, for example, had half of its loan purchases come through Loan Prospector in 1997. In 1997, Loan Prospector handled 528,000 loans with a total value of nearly $60 billion, more than double the previous year's figure. Fannie Mae's numbers show a similar growth pattern.

However, there is still value in using the more extensive residential mortgage credit reports, Fannie Mae's Coffay says. These reports help in areas where merged-file information is disputed.

Today RMCRs are ordered primarily when the merged repository report displays inaccurate, conflicting or disputed credit information. Bruce Baxter, vice president at Charter One Bank in Cleveland, Ohio, orders RMCRs only on a small percentage of loans. "The RMCRs we order are few and far between, usually on loans with major credit issues," says Baxter.

Ordering residential mortgage credit reports on loans with credit issues that need to be individually investigated has become the norm in recent years. Consequently, these reports are more difficult and costly to produce.

The lender who knows his business will tell applicants why they were turned down for a loan and will work with them to clean up any erroneous information, Magnuson says. The automated underwriting systems refer the information back to the lender, with an advisory regarding the credit report. The advisory might seek more detailed information or more information in a specific area.

Good credit-scoring models make the secondary market investor more comfortable about taking on higher risk. "The lender is responsible for the integrity of the information," Ferran adds.

Risk-based pricing opportunity

Freddie Mac is already starting to look into accepting some riskier loans - at higher prices - with the practice expected to become commonplace late this year or early in 1999. Also, good money can be made in the subprime market. Not all "good" applicants fall simply into a credit-scoring model. A more complete credit investigation can indicate good potential prospects who might otherwise be ignored. These credit investigations require much more work and might mean some additional initial expense, though the potential for profit can be significant, Olson says.

Lenders need to identify just what a credit score means. A 619 credit score, for example, is little different from a 620. Yet if the lender has a credit-scoring system that only approves loans with scores of 620 or higher, some very creditworthy borrowers could be automatically eliminated from consideration. By taking a closer look into the report with the 619, a lender might find that the applicant could be a good risk, particularly if a higher interest rate were charged for the loan to cover the higher risk factor.

While the difference of one point in a credit score is probably a minor item, Olson goes on to say there is a definite correlation between scores of 610 with higher default rates than there is for scores of 620. Olson says most lenders have yet to take full advantage of the potential of risk-based pricing.

Though some larger lenders have subsidiaries that deal in the subprime markets, other lenders are too risk-averse to follow a similar strategy. Olson suggests establishing a subsidiary dealing in the subprime market or working on a referral basis with a third-party subprime lender. "The subprime market can be very attractive," Olson says. So he expects risk-based pricing to become commonplace in the next few years, which will mean the accuracy of credit reports will be that much more critical.

Compliance with the Fair Credit Reporting Act and the 1997 amendments is not an option; it's the law. Complying with the terms of the new law, however, does not restrict or constrain marketplace activity, nor does it impose new onerous requirements.

Thoughtful lenders and good credit agencies realize that the key to success is creating a positive atmosphere for the consumer. For most consumers, getting a mortgage is the most important and complex financial transaction they will experience.

As the industry seeks to improve the lending process and deliver greater levels of convenience, it is important to keep in mind that quality credit information can make the difference between a good and bad experience for the borrower. The benefits of complete and accurate credit information far outweigh any nominal cost increase in the future.


* The amendments provide civil penalty liabilities and address improvements to the reinvestigation of the disputed information. The FTC can assess fines up to $2,500 per violation for the furnisher or the credit reporting agency or a creditor in violation of the Fair Credit Reporting Act.

* The law permits the filing of a counteraction (including legal fees) if a borrower brings a spurious lawsuit against the lender.

* It allows consumers to include more detailed explanations as to credit situations. This permits a more detailed explanation of why a negative item appears in the report. This might pertain to a dispute over faulty merchandise or other reason.

* Terms of offers must be stated conspicuously so that credit decisions can be made more easily.

* The new federal law will preempt state laws with certain exceptions. Federal law will preempt the following:

* Adverse action notification regulations as well as prescreen processes will preempt existing state laws.

* The obsolescence section of the Fair Credit Reporting Act as amended will preempt state law going forward, but existing state laws are grandfathered. Sections of the act that address the furnishing of credit information - statutes in Massachusetts and California have been grandfathered until 2004. The Firm Offer Clause for prescreens preempts state laws as does the Form and Content clause.

* When states enact laws designed to protect the consumer that do not conflict with the federal law, they will be allowed to stand.

* There is a clarification in the new law for obsolescence of a collection account. The seven-year period with accounts closed for collection or collection by an outside agency begins 180 days after commencement of the initial delinquency. For example, if a lender had a customer account that was 30 days delinquent in January 1998 and the lender worked it until October 1998 before sending it out for collection, the date of obsolescence calculations begins on July 7. Even though it was placed for collection in October, calculation begins 180 days after commencement of the initial delinquency, which would have been the end of January.

* If bankruptcies on Chapter 7 or Chapter 13 are withdrawn before final judgment, the bankruptcy may still be noted and reported on the credit report.

* Accounts that have been closed at the consumer's request must be noted on the credit report.

Richard Downing Jr. is executive vice president of The Credit Network in Framingham, Massachusetts. Founded in 1925, the company is the nation's largest independent credit reporting agency specializing in compiling credit information for the mortgage industry.
COPYRIGHT 1998 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1998 Gale, Cengage Learning. All rights reserved.

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Title Annotation:implications of Fair Credit Reporting Act in mortgage industry
Author:Downing, Richard, Jr.
Publication:Mortgage Banking
Date:Apr 1, 1998
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