Alert

Recent Issues Affecting Risk Based Pricing

Fall 2010

The Federal Trade Commission (the “Commission”) [1] and the Federal Reserve Board (the “Board”) [2] recently issued rules implementing a provision of the Fair and Accurate Credit Transactions Act [3] (the “FACT Act”) that has been pending since the FACT Act’s adoption in 2003.  The FACT Act added section 615(h) to the Fair Credit Reporting Act (“FCRA”).  Section 615(h) requires a creditor to notify a consumer when it uses a consumer credit report in connection with a credit application and, based on the report, grants credit to the 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. [4]  In other words, FCRA § 615(h) requires creditors to notify consumers whenever the creditor uses risk-based pricing for its credit products.

There is a complex set of rules for determining which consumers must receive a notice but, before considering those rules, it is important to note that there are a number of exceptions to the requirement to provide a risk-based pricing notice.  These exceptions apply to certain applications for specific terms, adverse action notices, prescreened solicitations, loans secured by residential real property, other extensions of credit and customers for whom a credit score is not available.  If a creditor cannot meet one of these exceptions or chooses not to provide the credit score disclosures to all consumers who apply for a credit product that involves risk-based pricing, the creditor must provide risk-based pricing notices to certain consumers.  The creditor can choose one of the following three alternative methods for determining which consumers must receive a notice: (1) a direct comparison approach; (2) a credit score proxy method; or (3) tiered pricing method.  The new rules provide detailed instructions on each alternative, as well as a fourth alternative specific to credit card issuers.

A creditor must also provide a risk-based pricing notice if the creditor uses a consumer credit report in connection with a review of existing credit and, based in whole or in part on the consumer report, increases the APR applicable to the previous extension of credit.  As a practical matter, this requirement will most often apply in the context of a credit card or other form of open-end credit.

The new rules also provide specific instructions for the content, form and timing of the risk-based pricing notices.  Model forms are included and provide creditors with certain safe harbors.  The timing rules vary with respect to closed and open-end credit, with special timing rules applying to direct automobile financing transactions and open-end credit plan established for the purpose of financing the contemporaneous purchase of goods or services.

Enforcement is left exclusively to each bank’s regulatory agency.  A consumer has no private cause of action against a creditor for its failure to comply with the risk-based pricing notice requirements.

These new rules are effective on January 1, 2011.

[2] The Board’s rules, which form a new Subpart H to Regulation V, 12 C.F.R §§ 222.70-75 (“Subpart H”), apply to all other creditors, including federally-insured depository institutions.  The Board did not publish any commentary, but there is some guidance for compliance in the examples that are scattered throughout the rule as well as in the model forms.

[3] The Fair and Accurate Credit Transactions Act of 2003, Pub. L. No. 108-159, 117 Stat. 1952.

[4]“Material terms” and “materially less favorable” are defined by regulation.  See 12 C.F.R. § 222.71(n); 12 C.F.R. § 222.71(o).