Have you ever wondered how the interest rate you got on a loan or credit card compares to what other borrowers were given? Historically, risk-based pricing has been a black box where consumers apply for credit and hope for the best, but never know if they're getting it, and if not, why not. That is beginning to change, however. As of January 1st such decisions will no longer be as mysterious. A new rule has taken effect that requires lenders to notify consumers if they didn't receive the best loan credit available, and borrows will also begin to find out part of the reason why. This new regulation should help to provide much more transparency to consumers on credit decisions.
Mark Greene, CEO of credit score firm FICO, appeared on CNBC's Squawk Box today to explain the new rule (full video clip below):
Risk-based pricing is a new set of legislation enacted by the Fed and the FTC a few months ago. It says that as of the 1st of this year, anytime a bank makes a lending decision about a consumer that's either adverse, they deny the credit or they grant credit at less than most favorable terms, they have to explain why. They have to show the data that they use. Typically, that's a FICO credit score -- a number between 300 and 850. And they have to explain what it was about the score that they didn't like that led them to have this adverse action for the consumer.
To be exact, the new rule does not explicitly force lenders to provide an explanation for why they were given less-than-ideal loan terms -- yet. At this time, a lender has two options: it can either tell a borrower that it received a rate that wasn't the lowest, or it can do so and provide their credit score, which would include some information about what score would have been necessary to attain the best terms. But in July, a provision of the Dodd-Frank financial regulation bill will eliminate that first option, forcing lenders to provide the credit score and some explanation of the rationale that led to that score.