Most businesses are willing to tolerate some degree of risk. Finance companies, in particular, operate in the inherent “risk zone.” But in the post-Dodd-Frank brave new world, many finance companies are undertaking compliance risks without even knowing it.
In today’s post, we review the Risk-Based Pricing Rule under the Fair Credit Reporting Act. The Rule generally requires disclosures to be given by companies that are engaging in “risk-based pricing” (i.e., the practice of adjusting terms of credit based on information in a consumer report).
This has been a particularly challenging regulation for two reasons. First, there is confusion over whether and when the Rule applies. For example, many finance companies do not change pricing for a particular loan amount (e.g., all $1,000 loans have the same APR). However, the consumer may not qualify for the requested loan amount based on information in a consumer report. If the company “down-sells” to a lower loan amount, it may be engaging in risk-based pricing. Second, the Rule is complicated in terms of which customers do and do not receive a risk-based pricing notice.
To summarize key provisions of the Rule:
- A company must give a risk-based pricing notice to a consumer if (i) it uses a consumer report; and (ii) based on information in the consumer report, it provides credit “on material terms that are materially less favorable than the most favorable material terms” offered to a “substantial proportion” of other consumers. For finance companies, the relevant “material term” is APR. Risk-based pricing can also occur if a creditor changes material terms on an existing account.
- The hardest part of the Rule is determining which consumers receive the risk-based pricing notice. A company cannot simply give the notice to all consumers. The Rule lists three specific methods for making this determination: the direct comparison method, the credit score proxy method and the tiered pricing method. Each method has its own set of complicated rules.
- There are several exceptions, the most significant being the Credit Score Disclosure exception. If a company gives each applicant a disclosure that lists the consumer’s credit score and related information, the company does not have to give a risk-based pricing notice. The benefit to this approach is that a company can avoid having to determine who must receive the risk-based pricing notice. The drawback, of course, is the expense of providing a credit score to every applicant.
- The Dodd-Frank Act included amendments to the Rule that require disclosure of credit scores (if credit scores are used) in a risk-based pricing notice. The Rule includes model forms that satisfy the disclosure requirements.
All finance companies need to understand the Risk-Based Pricing Rule. Don’t risk it.