With the New Year comes new rules that allow consumers to better understand the connection between their credit rating and the cost of borrowing. As of January 1, if your application for a loan is rejected because of something in your credit report, the lender has to let you know. In addition, the lender must also notify you if you’re approved, but not given the best interest rate or loan terms based on your credit information.
The new “risk based pricing rules,” an amendment to the Fair Credit Reporting Act, provide much-needed transparency in lending, and may get consumers to pay a little closer attention to improving their credit scores. Consumers who apply and receive adverse loan terms can be notified either through a letter, stating the higher rate is due to a credit report review, or a letter providing the consumer with a free copy of the score used to make their decision.
This is important, because in the past credit bureaus have sold consumers “educational scores” that aren’t necessarily the actual scores lenders have used to make their decision, according to John Ulzheimer, a credit expert for SmartCredit.com.
The new rules apply only to lenders, not to insurance companies, landlords or utility providers — all whom use credit scores to set terms such as premiums, deposit requirements and rental requirements. But those three groups will have to comply with the rules in July, when the Fair Access to Credit Scores Act goes into effect. After that, any company that makes an adverse decision based on a credit score must disclose the score.
What difference can a score make? Consider a $200,000 fixed-rate mortgage. Someone with a FICO score of 760 or higher would receive an interest rate of 4.54 percent, which translates to a monthly payment of $1,018. The borrower would pay $166,484 in interest over the life of the loan.
For someone with a FICO score of 639 or below, the same mortgage would have an interest rate of 6.13 percent and a monthly payment of $1,216. Over the life of the loan, the borrower would pay $237,619 in interest — or more than $71,000. For tips on improving your credit score, see this story.