[jholzknecht]

We recently received the following question by email:

We have a loan officer who wants to offer a small unsecured loan product and base the interest rate on their credit score. We do not base our interest rate on credit scores on any of our other loans and do not reference this in our loan policy. We would need to update the loan policy and there is a disclosure involved in risk based pricing, correct? Not to mention how it is advertised will be different, right?

Any guidance you can give would be greatly appreciated.

Thanks.

[jholzknecht]

I could write a small book in response to this wide open question. Let me make a few suggestions to get you started.

1. Yes, a policy and procedures that establish the standards for using risk-based pricing should be adopted. In a strict risk-based system the score/rate guidelines should be formalized (i.e.; if your score is X then your rate is Y.) Will the system allow exceptions or overrides when the lender is not comfortable with the resulting rate? If so, the P & P should explain when exceptions or overides are allowed and establish a process for tracking exceptions/overrides over time. How frequent are the exceptions/overrides? What is the range of exceptions/overrides? What are the characteristics of borrowers receiving exceptions/overrides? What loan officers are making exceptions/overrides?

2.The Fair Credit Reporting Act and Regulation V, Section 1022.70, require risk-based pricing notices. There are options for providing such disclosures. One option uses a tier-pricinng approach to determine who needs to recieve the risk-based pricing notice. The exceptions in Section 1022.74 allow the lender to use an appropriate credit score notice in lieu of providing the risk-based pricing notice.

3.The disclosures required in an advertiseement are determined by the details included in the advertisement. If simply stating that a new small loan product is being offered, then not much specific informtion is required. If you are trying to disclose a rate, things get complicated. One option to simplify the process is to use a representative example. “If your credit score is X then the interest rate is Y.” Truth in Lending and Regulation Z require advertsing disclosures. The disclosures required for open-end credit are explaining Section 1026.16 and the requirements for closed-end credit are explaained in Section 1026.24. Don’t forget about UDAP concerns. Explaining complicated pricing mechanisms can become confusing and result in charges of “unfair” or “deceptive” practices.

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