When applying for a mortgage, order credit reports far ahead

WASHINGTON — When you discovered an error on your credit report in connection with a mortgage application, was it easy to get it corrected?

Or did you, like Rep. Gary Ackerman, D-N.Y., get a multimonth runaround from both the creditor who originally made the mistake and the credit bureau that failed to promptly amend your credit file?

Ackerman's complaint was just one of dozens that that surfaced last week in Capitol Hill hearings that have huge potential significance to anyone who applies for a home loan. The hearings were centered on the Fair Credit Reporting Act, a 33-year-old federal consumer-protection statute that few consumers know much about.

But a key focus was how credit-system errors and disclosure failures can cost homebuyers significant money when they apply for a mortgage. Banking and credit-industry witnesses at the hearing generally argued that while the American credit system may have some flaws, it is by far the most efficient in the world.

Consumer advocates presented starkly different assessments. Shanna L. Smith, president and CEO of the nonprofit National Fair Housing Alliance, said electronic mortgage underwriting systems — used by virtually all major lenders today to quote rates to applicants — frequently cause or enable borrowers to be steered to higher-cost loans.

When a loan applicant has a FICO score near or below a set threshold, typically the low 600s, most electronic underwriting systems flag the applicant and direct the lender to "manually" underwrite the transaction. That means the loan officer is supposed to show the applicant the underlying credit-report data and try to determine whether errors, omissions or other factors in the files may be depressing the score. The consumer then can use the amended credit report to get a better score and lower rate.

But Smith, whose organization conducts fair-lending "testing" of mortgage companies nationwide, said that often doesn't happen. Instead, she testified, "from interviews with hundreds of loan originators over the past five years, I have learned that at least half of (them) ... send the applicant to a (higher-cost) subprime lender rather than spend the time necessary to manually underwrite the loan."

The electronic underwriting systems now in widespread use throw "many healthy, viable babies out with the proverbial bath water," said Smith. In effect, large numbers of credit-worthy applicants get shunted into subprime, high-fee mortgages that are extra profitable for lenders and investors.

A credit agency CEO, Richard L. LeFebvre of AAA American Credit Bureau Inc., of Flagstaff, Ariz., told the hearing that although federal law guarantees consumers the right to an "adverse- action" notice anytime their credit file data causes them a "financial hardship," mortgage applicants routinely get no disclosure whatsoever when an underwriting computer pushes them into a higher-cost loan.

LeFebvre is a nationally known expert in "rapid rescoring" — essentially intervening in the loan-application process to correct or supplement credit data quickly enough to obtain the mortgage rate desired by the consumer. Dozens of independent credit-reporting companies around the country are licensed to perform rescoring services, working for brokers and lenders on behalf of consumer clients.

LeFebvre provided examples of how even small corrections of erroneous credit-file data can dramatically improve an applicant's credit scores. In one case, a married couple referred to his firm had a three-year credit history with no late payments, according to LeFebvre. Their "mid-FICO" score — the score typically used to price mortgages — was a solid 731, qualifying them for close to the lowest rates in the market.

But when a creditor erroneously reported a $10 missed payment on an account, according to LeFebvre, the couple's scores plunged into the 500s — throwing them into a high-rate, high-fee bracket.

(FICO scores are generated by running credit file data from each of the three national credit repositories — Equifax, Experian and Trans Union — through risk-prediction software developed by Fair Isaac & Co. Scores range from the upper 300s to the mid-800s, with high scores indicative of lower risk of nonpayment. Scores of people with relatively brief or "thin" credit histories tend to be affected most dramatically by erroneous negative items placed in their files, according to Fair Isaac.)

LeFebvre got the errors corrected on the couple's files, returning them to eligibility for a prime market rate on their loan.

The upshot for you as a borrower? Always order copies of your three credit files well in advance of any mortgage application and check for mistakes. (If you live in Maryland, Colorado, Massachusetts, New Jersey, Georgia or Vermont, you can request a copy of each of your credit files free of charge every year.)

Equally important, when your loan officer uses an electronic system to underwrite your application, ask whether you are being quoted the best rate available in the marketplace. If not, demand to see the credit data that caused you to be priced higher.