Chairwoman Roukema, Senator Schumer, Congressmen Cannon and Ford and other members of the Committee, thank you for the opportunity to testify before you today on consumer credit reform contemplated in H.R. 2856, the "Fair Credit Full Disclosure Act."

The following testimony supports lower interest expense for homebuyers and greater market efficiency for mortgages and mortgage backed securities. Three modest proposals can effectively and immediately improve the environment for borrowers in the United States.

1)  SCORES. Every holder of a valid Social Security Number should have access to their credit scores at each of the three dominant credit bureaus, (the "Bureaus"), Experian (Fair Isaac Model), Trans Union (Empirica) and Equifax (Beacon).

2)  METRICS. The credit risk model software creators (Fair Isaac and others) should be materially more forthcoming regarding exactly what their software measures. Tell the people where the rocks are and those willing will walk on water.

3)  REPORTING. All secured lenders on all single family homes should be required to report borrowers’ payment histories to each Bureau.

4)  COMMENTS OUTSIDE THE PURVIEW OF H.R. 2856. The Bureaus urgently need to improve customer service to borrowers commensurate with legitimate requirements of their other customers, the lending community. While the Committee should encourage immediate reform from within the Bureaus, the Committee should also contemplate under what circumstances government may be required to play a far more active role in the critical function of accurate credit data collection and management.

Background. Scores are a critical factor in determining interest rate.

As a mortgage broker engaged in developing appropriate financing structures for homebuyers, I am driven by competition with other mortgage brokers and retail branches of banks to identify optimal pricing for given structures and income levels. Since the beginning of 2000, most of the large lenders with whom we deal have engaged in various campaigns marketing "risk based pricing." For instance, at one institution, when a client has a middle credit score of 720 or better – instead of 719 – he or she qualifies for .125% less in rate as well as access to higher loan amounts and underwriting approval at as much as 50% DTI (Debt to Income Ratio) instead of 38%. When questioned about the seemingly arbitrary significance of one FICO point, the lender’s response was "You’ve got to draw the line somewhere." In other words, credit scores determining interest expense is already a (rapidly expanding) reality for mortgagors (borrowers). Consumers generally have no say or role in affecting their credit scores by the time a lender reviews every detail of their finances, while a transaction, typically the largest financial commitment of their lives, urgently looms.

Comment. Consumers deserve information materially affecting their living cost.

Borrowers will be able to plan more effectively for home purchases if they know their credit scores well in advance of submitting a loan application. The Fair Credit Reporting Act, ("FCRA") already effectively requires the Bureaus to mail consumers credit reports upon request. The existing acquisition process appears to be reasonable for both consumer and the Bureaus, thereby evidencing successful legislative reform. An additional requirement to include the credit score in the copy to consumer empowers the consumer dramatically – and gives the consumer the opportunity to actually become a better risk - at virtually no incremental expense to the Bureaus charged with disclosure. Given commensurate security measures, internet access by consumers – at their initiation - to their credit report would redefine consumer empowerment of the first order and set the bar high indeed for other areas of service to constituents.

Background. Very few consumers, rich or poor, have any idea what credit scores measure or how they are constructed.

Fair Isaac’s website www.fairisaac.com makes an attempt to demystify the credit score determination process. While Fair Isaac’s software is necessarily highly complex and subject to trade secret protection, their website tips regarding specific scoring of consumers’ credit profiles are less precise and consistent than they need to be. The site indicates "many" types of accounts and "specific" types of accounts are considered in the score, but does not lead the consumer to adopt an optimal profile.

Criticism of the secrecy regarding scoring methodology relates ultimately to consumer education. Most people, especially those with little background in banking or finance, don’t understand the harm they do to themselves – and to their future borrowing cost – when they pay their bills late. Many people, intelligent, well educated and wealthy as well as not, believe mortgage lenders, installment debt lenders and credit card companies actually prefer their business because they pay penalty fees and additional interest expense when they finally pay because they "got enough money together." This mistaken belief is but one result of non-disclosure of the scoring system. Whether the lenders prefer such customers or not, they do not reward them with lower interest rates. In fact, because of FICO scores, they do exactly the opposite.

Comment. Fair Isaac and other software designers should lead consumers to develop superior risk profiles.

Fair Isaac should be encouraged to disclose sample credit profiles evidencing given scores and include in the software the credit Bureaus use for each report specific targets, such as "your credit score would be 50, 100 and 150 points higher if the following specific conditions existed, and existed for twelve consecutive, or twenty four, or thirty six months."

The downside to such disclosure is that consumers with sufficient lead time could "reverse engineer" or manipulate their credit profiles to ape or mimic a theoretical ideal profile. They may no more intrinsically reflect true risk characteristics of that consumer than a wolf in sheep’s clothing presents its true predisposition. Those philosophically and politically against disclosure will argue default experience will exceed predicted levels and thereby harm all consumers by creating unpredicted costs, which will be borne by all, including those who pay their bills on time. Those in support of educational disclosure will argue that the information may not help everyone, but it will help those willing to help themselves. Even if only twenty per cent of Americans with less than perfect credit are willing to adopt the rigorous discipline to train themselves to actually become better credit risks, that’s progress. Profit opportunities would diminish for lenders who charge premium pricing for those upwardly mobile, self-improving, newly credit-conscious consumers, but efficiency in the capital markets is second only to home ownership as the quintessential American icon, and therefore deserving of enthusiastic support by this Committee.

Background. Sub-prime lenders do not uniformly report payments to credit Bureaus.

Certain borrowers, for a variety of reasons, represent greater credit risk than others. For a lender to receive higher interest rates, to compensate for higher probability of loss from default and foreclosure expenses, is appropriate. Those lenders may charge high transactions costs and include prepayment penalties, just as commercial lenders impose yield maintenance agreements. All the foregoing appears reasonable and defensible assuming an environment of adequate disclosure at the time the loan is originated. Many borrowers require capital on short notice or in spite of prior inability to pay on a timely basis, and these sub-prime lenders provide critical liquidity in the market, creating many opportunities which simply would not exist in "A credit" underwriting scenarios.

Such sub-prime borrowers may make their payments for two or three years without any incidences of late payments and then seek to refinance at "A credit" interest rates, which are normally much lower than sub-prime rates. If the sub-prime lenders have – intentionally – failed to report the timely (or otherwise) payment history to the Bureaus, then there is no public record of that borrower’s timely record of payment, and the borrower may not be eligible to refinance. The borrower is then trapped in a lending relationship beyond the period his or her actual payment history suggests is appropriate or fair.

Comment. Ask. Tell.

Withholding of timely payment information is tantamount to financial slavery and abuses the dignity of lender and borrower alike. If you have a secured interest in an American’s home, you should report timely payments to the Bureaus, even if it requires an Act of Congress.

The three points raised above deal largely with information to empower consumers before the home buying process begins and before derogatory information becomes part of the public record. By keeping these three proposals modest and achievable, this writer believes great improvement can be effected at very little expenditure of time and money.

Background. Garbage in, garbage out.

The process contemplated by FCRA does not adequately address the interests of those individuals with inaccurate information on their credit reports. While a process exists whereby Bureaus have 30 days to respond to consumers’ inquiries, in the real world, the Bureaus usually get no corrections from the reporting creditor because there is no coordination of the communication between borrower, creditor and Bureau. The borrower’s hopes, consequently, are falsely raised and subsequently dashed. Meanwhile, the borrower loses two to three precious months and has not achieved any results.

The mere fact that I see credit score ranges of more than 100 points on more than 30% of my clients proves that much of the date actually on file at the respective Bureaus is conflicting and therefore necessarily inaccurate. Call a good mortgage broker today and ask for all three of your credit scores. You may be surprised at the variance from one Bureau to the next, and you will be disadvantaged if your middle score is lower than certain thresholds.

I have seen hundreds of examples of borrowers who would have excellent credit but for relatives of similar name with bad credit, ex-spouses bent on credit report damage, fraudulent credit card use by criminals and myriad other derogatory credit line items which were not the fault of the borrower. One client has a 550 score largely because a former college "friend" had filed a judgment in the public record for $100 of disputed concert tickets. There are no late payments on his profile.

When consumers attempt to telephone directly, the wait times at the Bureaus are unacceptable. Consistency and accountability on "customer service" issues do not exist and there is an implicit "guilty until proven innocent" convention in evidence in virtually every communication I have ever witnessed or taken part with Experian, TransUnion and Equifax. The deletion, once and for all, of certain derogatory information in one’s credit profile, is something every consumer should have the opportunity to approach fairly. The only word fit to describe the existing condition process is "disgraceful."

Since every consumer with "legitimate" derogatory tradelines (which is to say, accurate reporting of late payments and defaults) would be advantaged by having such information excised, there is enormous risk and expense in determining which people have legitimate complaints and which people simply abuse the system in an attempt to engineer an improved score.

Comment. Let the professionals explain how they are helping the situation and avoiding further Congressional oversight.

Perhaps the optimal action step for the Committee is to invite the Bureaus to report on their progress since the passage of FCRA in walking the fine line between managing accurate information and preventing fraudulent obfuscation by borrowers unwilling to face facts about their past and commence constructive credit rehabilitation which, requires time and discipline.

Very few Americans love the Internal Revenue Service, and very few will ever love XPN, TU or EFX. If I ran one of the Bureaus, however, and I didn’t want Congress to legislate my firm out of existence, I would place the highest priority on measuring customer satisfaction with borrowers as well as lenders and then bringing in the best minds in the business to optimize both (some borrowers should be unsatisfied!). Credit report expense would likely increase, but more people would pay better attention to their credit. It’s not easy being the most creditworthy nation on earth, but it’s best for the United States.

Respectfully submitted,

Alexander J. Arader
President, Arader & O’Rourke, Inc.