From one mortgage loan applicant to another, the stories and financial information can vary greatly. Loan officers and underwriters face a challenge putting the pieces together for each applicant to solve the “creditworthiness puzzle.” When the pieces all fit, it’s a beautiful thing, but, when you end up with pieces missing or pieces that don’t fit anywhere in the picture, often the only viable action is to deny the request for credit.
So, how much do you have to say about the reasons the credit application is being denied? Some applicants’ credit reports and other documentation read like a never-ending horror story. How much is too much?
Basics of Credit Denial
A creditor must notify an applicant of action taken on the applicant’s request for credit, whether favorable or adverse, within 30 days after receiving a completed application. Notification of adverse action taken on an existing account must also be made within 30 days.
A notification of adverse action must be in writing and must contain certain information, including the name and address of the creditor and the nature of the action that was taken. In addition, the creditor must provide an ECOA notice that includes the identity of the federal agency responsible for enforcing compliance with the act for that creditor. This notice is generally included on the notification of adverse action.
The creditor must also either provide the applicant with the specific principal reason(s) for the action taken or disclose that the applicant has the right to request the reason(s) for denial within 60 days of receipt of the creditor’s notification, along with the name, address, and telephone number of the person who can provide the specific reason(s) for the adverse action. The reason may be given orally if the creditor also advises the applicant of the right to obtain the reason in writing upon request.
Reasons for Credit Denial
The nature of the reasons for credit denial may be founded in the applicant’s credit history or record, or it may be a combination of the credit information provided and the creditor’s articulated lending standards. Regulation B – Equal Credit Opportunity Act recognizes that “the statement of reasons for adverse action must be specific and indicate the principal reason(s) for the adverse action. Statements that the adverse action was based on the creditor’s internal standards or policies or that the applicant, joint applicant, or similar party failed to achieve a qualifying score on the creditor’s credit scoring system are insufficient.”
You may be faced, though, with numerous reasons to deny the credit application. So, how do you pare them down, how do you give enough information, but, not too much?
Regulation B Official Staff Interpretations §1002.9(b)(2) provides guidance.
- “Number of specific reasons. A creditor must disclose the principal reasons for denying an application or taking other adverse action. The regulation does not mandate that a specific number of reasons be disclosed, but disclosure of more than four reasons is not likely to be helpful to the applicant. [Emphasis added]
- Source of specific reasons. The specific reasons disclosed [under the regulation] must relate to and accurately describe the factors actually considered or scored by a creditor.
- Description of reasons. A creditor need not describe how or why a factor adversely affected an applicant. For example, the notice may say “length of residence” rather than “too short a period of residence.”
- Credit scoring system. If a creditor bases the denial or other adverse action on a credit scoring system, the reasons disclosed must relate only to those factors actually scored in the system. Moreover, no factor that was a principal reason for adverse action may be excluded from disclosure. The creditor must disclose the actual reasons for denial (for example, “age of automobile”) even if the relationship of that factor to predicting creditworthiness may not be clear to the applicant.
- Credit scoring—method for selecting reasons. The regulation does not require that any one method be used for selecting reasons for a credit denial or other adverse action that is based on a credit scoring system. Various methods will meet the requirements of the regulation. One method is to identify the factors for which the applicant’s score fell furthest below the average score for each of those factors achieved by applicants whose total score was at or slightly above the minimum passing score. Another method is to identify the factors for which the applicant’s score fell furthest below the average score for each of those factors achieved by all applicants. These average scores could be calculated during the development or use of the system. Any other method that produces results substantially similar to either of these methods is also acceptable under the regulation.
- Judgmental system. If a creditor uses a judgmental system, the reasons for the denial or other adverse action must relate to those factors in the applicant’s record actually reviewed by the person making the decision.
- Combined credit scoring and judgmental system. If a creditor denies an application based on a credit evaluation system that employs both credit scoring and judgmental components, the reasons for the denial must come from the component of the system that the applicant failed. For example, if a creditor initially credit scores an application and denies the credit request as a result of that scoring, the reasons disclosed to the applicant must relate to the factors scored in the system. If the application passes the credit scoring stage but the creditor then denies the credit request based on a judgmental assessment of the applicant’s record, the reasons disclosed must relate to the factors reviewed judgmentally, even if the factors were also considered in the credit scoring component. If the application is not approved or denied as a result of the credit scoring, but falls into a gray band, and the creditor performs a judgmental assessment and denies the credit after that assessment, the reasons disclosed must come from both components of the system. The same result applies where a judgmental assessment is the first component of the combined system. As provided in [the Official Staff Interpretation], disclosure of more than a combined total of four reasons is not likely to be helpful to the applicant.
- Automatic denial. Some credit decision methods contain features that call for automatic denial because of one or more negative factors in the applicant’s record (such as the applicant’s previous bad credit history with that creditor, the applicant’s declaration of bankruptcy, or the fact that the applicant is a minor). When a creditor denies the credit request because of an automatic-denial factor, the creditor must disclose that specific factor.
- Combined ECOA-FCRA disclosures. The ECOA requires disclosure of the principal reasons for denying or taking other adverse action on an application for an extension of credit. The Fair Credit Reporting Act (FCRA) requires a creditor to disclose when it has based its decision in whole or in part on information from a source other than the applicant or its own files. Disclosing that a consumer report was obtained and used in the denial of the application, as the FCRA requires, does not satisfy the ECOA requirement to disclose specific reasons. For example, if the applicant’s credit history reveals delinquent credit obligations and the application is denied for that reason, to satisfy [the regulation] the creditor must disclose that the application was denied because of the applicant’s delinquent credit obligations. The FCRA also requires a creditor to disclose, as applicable, a credit score it used in taking adverse action along with related information, including up to four key factors that adversely affected the consumer’s credit score (or up to five factors if the number of inquiries made with respect to that consumer report is a key factor). Disclosing the key factors that adversely affected the consumer’s credit score does not satisfy the ECOA requirement to disclose specific reasons for denying or taking other adverse action on an application or extension of credit. Sample forms C-1 through C-5 of appendix C of the regulation provide for both the ECOA and FCRA disclosures.”
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