By John B.C. Porter, Esq.
Effective January 1, 2011, credit unions that use consumer reports in connection with an extension of credit used for personal, family, or household purposes and provides this credit to the member on material terms that are materially less favorable than the most favorable material terms available to a substantial proportion of members of the credit union must provide the member a “risk-based pricing notice.” This requirement is one of the final vestiges of the Fair and Accurate Credit Transactions Act.
Just exactly what constitutes “material terms that are materially less favorable than the most favorable material terms”? In almost all cases, we’re talking about the annual percentage rate. Specifically, for open-end loans, it is the annual percentage rate, excluding any temporary initial rate that is lower than the rate that will apply after the temporary rate expires, any penalty rate that will apply upon the occurrence of one or more specific events, and any fixed annual percentage rate option for a home equity line of credit. For credit cards, it is the annual percentage rate that applies to purchases; and for closed-end credit, it is also the annual percentage rate. “Materially less favorable” means material terms (i.e., APR) provided to a member that differ from the terms provided to another member such that the cost of credit to the first member would be significantly greater than the cost of credit provided to the other member.
How do you know what members are receiving material terms that are materially less favorable than the most favorable material terms? Well, you could determine this by directly comparing the material terms offered to each member and the material terms offered to other members for a specific type of credit product. Who wants to do that? No one! The Federal Reserve has given credit unions easier options.
The first of which is the credit score proxy method. This method involves, through use of a representative sample of the members to which the credit union provided credit by specific credit products, determining the “cutoff score” that represents the point at which approximately 40 percent of the members to whom the credit union provides credit have higher credit scores and approximately 60 percent of the members to whom it provides credit have lower credit scores. The members who fall below the cutoff score would receive the risk-based pricing notice. This cutoff score must be recalculated no less than every two years.
For example, your credit union engages in risk-based pricing and the annual percentage rates it offers to members are based in part on credit score. The credit union takes a representative sample of its members’ credit scores to whom the credit union issued credit cards within the preceding three months. The credit union determines that approximately 40 percent of the sampled members have a credit score at or above 720. Thus, 720 is the cutoff score. A member applies to the credit union for a credit card. The credit union obtains a credit score for the member. The member’s credit score is 700. Since the member’s credit score falls below the 720 cutoff score, the credit union must provide a risk-based pricing notice to the member.
A credit union’s second option is to use the tiered pricing method. If a credit union sets the material terms of credit provided to a member by placing the member within one of a discrete number of pricing tiers for a specific type of credit product, based in part on a consumer report, the credit union may provide a risk-based pricing notice to each member who is not placed within the top pricing tier or tiers. If the tiered pricing has four or fewer pricing tiers, the credit union complies with the risk-based pricing notice requirement by providing the notice to each member to whom the credit union provides credit who does not qualify for the top tier. If there are five or more pricing tiers, the risk-based pricing notice must be given to each member who receives credit from the credit union who does not qualify for the top two tiers and any other tier that, together with the top two tiers, comprise no less than the top 30 percent, but no more than the top 40 percent, of the total number of tiers. For example, if a credit union has nine pricing tiers, the top three tiers comprise no less than the top 30 percent, but no more than the top 40 percent, of the tiers. Therefore, the credit union would provide a risk-based pricing notice to each member to whom it provides credit who falls within the bottom six tiers.
Alternatively, a credit union that issues credit cards may satisfy its obligation to provide the risk-based pricing notice to a member when it provides this notice to: (a) members who apply for a credit card either in connection with an application program, such as a direct mail offer or a take-one application, or in response to a solicitation and more than one possible annual percentage rates for purchases may apply under the program or solicitation and (b) based in part on a consumer report, the credit union provides a credit card to the member with an annual percentage rate that is greater than the lowest annual percentage rate available in connection with the application or solicitation. A credit union that issues credit cards, however, is not required to comply with the risk-based pricing notice if the member applies for a credit card for which the credit union provides a single annual percentage rate or the credit union offers the member the lowest annual percentage rate available under the credit card offer for which the member applied, even if a lower annual percentage rate is available under a different credit card offer issued by that credit union.
Credit unions must also provide members risk-based pricing notices when the credit union uses a consumer report in connection with a review of credit that has been extended to the member and, based at least in part on the consumer report, increases the annual percentage rate.
In closed-end credit transactions, the risk-based pricing notice must be provided to the member before consummation of the transaction, but not earlier than the time the decision to approve an application is communicated to the member. For open-end credit transactions, the risk-based pricing notice must be provided to the member before the first transaction is made under the plan, but not earlier than the time the decision to approve an application for credit is communicated to the member. In the case of a review of credit that has been extended to the member, the risk-based pricing notice must be provided to the member at the time the decision to increase the annual percentage rate based on a consumer report is communicated to the member. In cases where credit unions have contracted with third parties to facilitate credit transactions, e.g., automobile dealerships, third parties may provide the member with the risk-based pricing notice (even if a different credit score is obtained and used) within the timelines prescribed, thereby satisfying the credit union’s obligation.
Credit unions are not required to provide a risk-based pricing notice to members when members apply for specific material terms and those material terms are granted. For example, a member receives a firm offer of credit from a credit union. The terms of the firm offer are based in part on information from a consumer report that the credit union obtained under the Fair Credit Reporting Act’s firm offer of credit provisions. The solicitation offers the member a credit card with a single purchase annual percentage rate of 12 percent. The member applies for and receives a credit card with an annual percentage rate of 12 percent. Other members with the same credit card have a purchase annual percentage rate of 10 percent. Because the member applied for specific material terms and those material terms were granted, the credit union does not need to provide the member with an annual percentage rate of 12 percent with a risk-based pricing notice. Furthermore, in the event the member is declined credit altogether, credit unions need not send those members risk-based pricing notices if they provide said members with adverse action notices.
There is a final exception or alternative to providing the risk-based pricing notice as described above. Credit unions may choose to provide a credit score disclosure to every member who applies for and is provided credit by the credit union. Depending on the composition of your membership’s creditworthiness, this may be an attractive alternative for you. Appendix H to Regulation V provides model risk-based pricing notices and the exception notice. I implore you to use these notices to comply with these recent requirements under the FACT Act.
John B. C. Porter is a Managing Attorney in the Columbus Credit Union group. He can be reached at (614) 857-4488 or firstname.lastname@example.org.