In discussing the Fair Credit Reporting Act, one question I often receive is whether or not the credit score exception notice must be provided when an application is denied and the applicant is receiving an adverse action notice. The thought is that the credit score information is included on the adverse action notice, so why would the credit score exception notice - that basically provides the exact same information - still be required?
Believe it or not, this question is actually quit complex, so I will do my best to explain this for you.
Understanding the Credit Score Exception Notice
The credit score exception notice (model forms H-3, H-4, H-5) is a disclosure that is provided in lieu of the risk-based-pricing notice (RBPN, which are H-1, H-2, H-6 & H-7). The RBPN is required any time a financial institution provides different rates based on the credit score of the applicant. As the requirements for the RBPN are actually quite complex (proxy method or tiered method), the Federal Reserve gave financial institutions an easier way to comply: to provide the credit score exception notice instead of the RBPN. This alternative is found in 1022.74 of Reg V (FCRA) which lists some exceptions where the RBPN is not required.
As explained, one of the exceptions to the RBPN is when you provide the alternative credit score exception notice. Now, when you look a little further into the exceptions, you will find that another exception is if you provide an AA notice. This is found in 1022.74(b) as follows:
(b) Adverse action notice. A person is not required to provide a risk-based pricing notice to the consumer under §1022.72(a), (c), or (d) if the person provides an adverse action notice to the consumer under section 615(a) of the FCRA.
So in summary, the RBPN is not required when an AA notice is provided. What this really means is that the credit score exception notice is not needed either because the reason that form is sent is to satisfy the requirement to send the RBPN. The 1st Quarter 2012 publication of Consumer Compliance Outlook (from the FRB) makes this clear in their Q&A:
QUESTIONS AND ANSWERS 1. Must risk-based pricing notices be provided to denied applicants?
Section 1022.72(a) of Regulation V (12 C.F.R. Part 1022) specifies when a creditor must provide a risk based pricing notice to a consumer applying for credit, subject to the exceptions in §1022.74. If an application is denied and an adverse action notice is provided, a risk-based pricing or exception notice is not required. See §1022.74(b). (The full publication can be found here: https://consumercomplianceoutlook.org/2012/first-quarter/risk-based-pricing-notice-requirements/)
Now, the challenge with this is that - upon first glance - the exception for sending an adverse action notice appears to only apply to the risk based pricing disclosure, and not the exception notice. The reason for this thought is that the credit score exception notice is supposed to be sent to "all" applicants.
Well, the Federal Reserve thought about this and how the language appears to be worded so that the exception notice doesn't clearly have an exception similar to the one for the risk-based pricing notice. Specifically, the Federal Reserve explains in the preamble to the final rule that if the adverse action exemption applies, the credit score exception notice does not need to be provided:
"One commenter believed that the Agencies’ statement that a creditor must provide a credit score disclosure exception notice to ‘‘all’’ consumers was too broad, noting that some consumers may not be entitled to receive any type of notice under the rules. The Agencies agree that some consumers would not receive an exception notice... Creditors also do not need to provide an exception notice to a consumer if one of the other exceptions applies. For example, consumers who apply for and receive a specific rate or who receive an adverse action notice pursuant to the exceptions under §ll.74(a) and §ll.74(b), respectively, are not entitled to a notice."
Therefore, we can see that the Fed is clear that neither the risk-based pricing notice, nor the credit score exception notice are required if an adverse action notice is provided to the applicant.
All of that said, there are thee other considerations we must look at before we just stop sending the credit score exception notice:
- The Notice to Home Loan Applicant
- The "credit score disclosure" required under 609(g)
- Timing requirements for non-RE loans
Notice to Home Loan Applicant
The first thing we need to discuss is the Notice to Home Loan Applicant (NTHLA) which applies to 1-4 family consumer mortgages. This rule comes from section 609(g)(1) of the FCRA as follows:
"In general. Any person who makes or arranges loans and who uses a consumer credit score, as defined in subsection (f), in connection with an application initiated or sought by a consumer for a closed end loan or the establishment of an open end loan for a consumer purpose that is secured by 1 to 4 units of residential real property (hereafter in this subsection referred to as the lender) shall provide the following to the consumer as soon as reasonably practicable:" of which the Notice to Home Loan Applicant is described in subsection (D).”
This requirement to deliver the NTHLA is a separate rule from the RBPN, but is incorporated into the credit score exception notice (H-3), meaning that the H-3 complies with both the RBPN and the NTHLA requirements. The problem, however, is that the NTHLA is still required even if the application is denied. This means that if a creditor were to not send the credit score exception notice (H-3) on a denial for a 1-4 family consumer mortgage application, the NTHLA disclosure would still need to be provided.
Credit Score Disclosure
Section 609(g) referenced above has another requirement where a creditor must send a "credit score disclosure" to an applicant of a consumer loan secured by 1 to 4 units of residential real property. This requirement, too, is generally satisfied by sending model form H-3. If a creditor did not provide model form H-3 for loans secured by 1 to 4 units of residential real property, the following information would still need to be provided to the applicant under 609(g) of the FCRA:
(A) the current credit score of the consumer or the most recent credit score of the consumer that was previously calculated by the credit reporting agency for a purpose related to the extension of credit;
(B) the range of possible credit scores under the model used;
(C) all of the key factors that adversely affected the credit score of the consumer in the model used, the total number of which shall not exceed 4, subject to paragraph (9);
(D) the date on which the credit score was created; and
(E) the name of the person or entity that provided the credit score or credit file upon which the credit score was created.
Again, the provision found in 609(g) of the FCRA only applies to consumer loans secured by 1 to 4 units of residential property.
Timing Requirements for Non-RE Loans
The final consideration relates to the timing requirements for non-real estate loans. As discussed previously, the risk-based pricing notice/credit score exception notice is not required on a non-real estate loan if an adverse action notice is provided to the applicant containing the information required by section 615(a) of the FCRA:
(b) Adverse action notice. A person is not required to provide a risk-based pricing notice to the consumer under §1022.72(a), (c), or (d) if the person provides an adverse action notice to the consumer under section 615(a) of the FCRA.
There is one quirk to this rule, however. The timing rules for delivering the exception notice state that the disclosure must be provided “as soon as reasonably practicable,” which is often viewed as within 3 days. Therefore, if you don’t deny a non-real estate consumer mortgage application right away, you still need to send the credit score exception notice.
The timing requirement for a non-RE loan (using model form H-4) is as follows:
(3) Timing. The notice described in paragraph (e)(1)(ii) of this section must be provided to the consumer as soon as reasonably practicable after the credit score has been obtained, but in any event at or before consummation in the case of closed-end credit or before the first transaction is made under an open-end credit plan.
In addition, if a credit score was not available, a financial institution will provide model form H-5 which has the following timing requirements:
(4) Timing. The notice described in paragraph (f)(1)(iii) of this section must be provided to the consumer as soon as reasonably practicable after the person has requested the credit score, but in any event not later than consummation of a transaction in the case of closed-end credit or when the first transaction is made under an open-end credit plan.
The preamble to the final rule explains the challenge with timing requirements as follows:
"The Agencies note, however, that reliance on the other exceptions may not be possible in certain cases because the timing rules require the credit score disclosure exception notices to be provided to the consumer as soon as reasonably practicable after the credit score is obtained. For example, a mortgage lender may obtain a consumer’s credit score and, in order to meet the timing requirements, provide an exception notice to the consumer within several days. However, the lender may ultimately determine after a more lengthy credit underwriting process, that it will not extend credit to the consumer and therefore provide an adverse action notice to the consumer. The Agencies note that for purposes of providing credit score disclosure exception notices to a consumer as soon as reasonably practicable after a credit score is obtained, what is a reasonably practicable time period may be different depending on the circumstances of the transaction and the type of credit. For example, while it may be reasonably practicable to provide a notice to a consumer in several days in the mortgage lending context, what is reasonably practicable in other forms of credit may be a shorter or longer time period."
The Bottom Line
In summary, the credit score exception notice is technically not required on denied loans except for three reasons. First, the NTHLA (which is included in the exception notice) is still required for a denied application for a 1-4 family consumer mortgage. Secondly, 1-4 family consumer mortgage applications require a "credit score disclosure" under 609(g) of the FCRA. Finally, the credit score exception notice would be required for non-real estate loans if the adverse action notice is not immediately sent after the credit report was pulled.
Based on the above, you can see that the best practice is to just send the credit score exception notice for all denials. The easiest way for financial institutions to do this is to contract with their credit reporting agency (credit bureau) to have them send the required notice any time a credit report is obtained by the financial institution.