As I mentioned in a previous blog post, a new rule for risked based pricing issued by the Federal Reserve Board and the Federal Trade Commission will go into effect January 1, 2011.  The new regulation will require any company that uses a credit report or score in connection with a credit decision (including companies such as banks, mortgage bankers, auto lenders, retailers, and public utilities) to send a new type notice to a consumer when the company grants credit based on a credit report or score on "material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers".

That makes perfect sense, right?    As unclear as the new regulation may sound, understanding how this rule works is imperative to developing an effective compliance program.  Basically, the new risk-based pricing regulation requires the implementation of new procedures and policies for determining which consumers must receive a risk-based pricing or credit score disclosure notice.  The Agencies have provided companies with a variety of compliance options, depending on their type of business.  The options include either a case-by-case approach or one of the two alternatives: "credit score proxy" and "tiered pricing" methods.  Let's see if we can't make sense of the different approaches.

Case-by-Case:    Lenders using the case-by-case approach must compare the material terms offered to the consumer applying to offers made to other consumers, for the same type of credit product.  This approach is more time consuming and leaves the business with compliance exposure due to human error.

Credit Score Proxy:    Using the credit score proxy method, creditors may determine a cutoff score where 40% of its consumers have higher credit scores and 60% have lower credit scores. Then a risk-based pricing notice would be given to anyone with a credit score in the lower 60th percentile. Every two years these score thresholds must be recalculated using a sampling of the lender's customer base.

Tiered Pricing:    According to the Federal Reserve, using the tiered pricing method, creditors set the "material terms of credit granted, extended, or provided to a consumer by placing the consumer within one of a discrete number of pricing tiers for a specific type of credit product, based in whole or in part on a consumer report."  Creditors then comply with the new requirements by providing a risk-based pricing notice to each consumer who is not placed within the top pricing tier or tiers.

Furthermore, a notice is required if a consumer applies for a credit card with a multiple-rate offer and is granted credit at an annual percentage rate higher than the lowest rate available under that offer.  The same can be said with regard to the required notice, if after a periodical account review, a creditor increases the APR for a customer based on information obtained through a consumer report.