This afternoon, the Federal Reserve and Federal Trade Commission announced a new final rule which would require banks and finance companies to disclose more information to consumers to justify the credit terms provided. The rule should provide customers with a better idea of why their loans and other credit products were so expensive or so cheap by explaining where each individual falls in the company's risk-based pricing strategy. Consumers should celebrate.
The new rule goes into effect on January 1, 2011. Here's most of the press release:
The Federal Reserve Board and the Federal Trade Commission today announced final rules that generally require a creditor to provide a consumer with a notice when, based on the consumer's credit report, the creditor provides credit to the consumer on less favorable terms than it provides to other consumers. Consumers who receive this "risk-based pricing" notice will be able to obtain a free credit report to check the accuracy of the report.
Risk-based pricing refers to the practice of setting or adjusting the price and other terms of credit provided to a particular consumer based on the consumer's creditworthiness. The final rules provide creditors with several methods for determining which consumers must receive risk-based pricing notices.
As an alternative to providing risk-based pricing notices, the final rules permit creditors to provide consumers who apply for credit with a free credit score and information about their score. Today, most consumers must pay a fee to obtain their credit score.
So let's say you get a loan to buy a new car. The dealership gives you a 7% interest rate. Unless that's the lowest rate it would extend to anyone, the creditor must explain to you why you didn't qualify for a lower interest rate. Clearly this is pretty big news, as it's a significant departure from practice. Up to now, if you asked why the rate was so high, all the creditor would really do is shrug.
Not only will the company have to explain why it didn't give you a better deal, but they'll have to back it up by providing you with your own credit report and score -- for free. Again, this is pretty huge. You can literally check creditors' work to make sure you're getting the price you should be according to their underwriting scheme.
Clearly, banks and finance companies will absolutely hate this rule. It makes their credit process seem less like a black box. Usually, when you get a credit offer from a firm, as a consumer all you can really do is say "no" or look for a better deal elsewhere. You could never really ask why you didn't get a better rate, or even know if a better rate was offered to other people. That's all in the past, which means that banks and finance companies won't be able to play as many games.
As much as creditors might whine about the new rule, I find it hard to think of any legitimate reason why they are really any worse off, other than losing the ability to swindle some customers. If a finance company is an upright operation, then it should be completely unaffected. It just needs to explain itself. There's also no real fear of competitors discovering their underwriting methodology through this transparency, since the full results of all customers aren't being disclosed -- it's just being done on an individual basis. It would be next to impossible for a competitor to try to aggregate all of that information and back into another firm's underwriting strategy.
I'm a huge fan of this kind of financial regulation, which seeks to provide Americans with more information about their credit so they can better understand their debt costs and what affects their creditworthiness. This is a huge win for consumers, and it was done without any legislation, because the Federal Reserve and Federal Trade Commission instituted the rule. This is pretty aggressive regulation, however, so I wonder if this could be part of a new effort where regulators take off the gloves when it comes to protecting consumers. One can only hope.