Suit challenges Freddie Mac credit checks

Nation's Housing

October 27, 2002|By KENNETH HARNEY

A CLASS ACTION lawsuit against the country's second-largest source of home loan money - Freddie Mac - is focusing new attention on a consumer protection statute that's probably unfamiliar to many homebuyers and mortgage borrowers.

The federal Fair Credit Reporting Act governs lenders, landlords and others who obtain and use credit reports and scores to make decisions on consumers' applications. If a lender uses credit file information to reject an applicant or charge a higher interest rate, the lender is required to provide what the law terms an "adverse action" notice.

That notice explains what adverse action was taken and identifies the credit reporting agencies whose information contributed to the rejection or higher costs. The applicant can then challenge or seek to correct the credit file data if it is erroneous.

The class action lawsuit against Freddie Mac charges that hundreds of thousands of home loan applicants nationwide have been rejected or assessed higher fees through the corporation's electronic underwriting system - without receiving the required notices and protections of the Fair Credit Reporting Act.

Filed in U.S. District Court in Philadelphia, the lawsuit accuses Freddie Mac of multiple violations of the law and asks for substantial monetary damages on behalf of all mortgage applicants rejected or charged higher rates through Freddie Mac's underwriting system during the past two years.

Freddie Mac officials had no immediate comment.

The lead plaintiff in the case is Donald Weidman of Philadelphia, who applied for a home mortgage last year through several lenders who used Freddie Mac's electronic underwriting system to process his applications. The system, known as Loan Prospector, allows lenders around the country to submit applications online and to receive a funding and pricing decision almost instantaneously from Freddie Mac.

A congressionally chartered private corporation based in McLean, Va., Freddie Mac is not a direct lender itself. Instead, it purchases billions of dollars in mortgages annually from thousands of originating lenders nationwide. It retains the loans in its investment portfolio or packages them into bonds for sale to other investors.

Though the details of Loan Prospector are proprietary secrets, Freddie Mac has confirmed that the system orders and runs credit file data through statistical models to evaluate borrower risk. Rival mortgage investor Fannie Mae has a similar electronic system and was sued in a class action lawsuit last month alleging violations of fair-lending, equal credit opportunity and fair-credit legislation. Fannie Mae denied the allegations, but has yet to respond to the lawsuit in federal court, according to a spokesman.

Weidman's lawsuit charges that each of his mortgage applications submitted to local lenders was processed through Freddie Mac's system, using data obtained from the three national credit repositories - Experian, Equifax and TransUnion. Based on Freddie Mac's negative electronic evaluation, the lawsuit says, Weidman was denied the interest rate and terms he sought from each lender.

The lawsuit charges that although Freddie Mac is subject to the Fair Credit Reporting Act, it never provided him an explanation of its adverse evaluation, never identified the sources of its credit information, and never afforded him an opportunity to review the credit file data that caused him harm as a loan applicant.

At the core of the case, say banking industry lawyers and consumer advocates, is an unresolved issue that has been festering for half a decade: On the one hand, mass-market electronic underwriting systems such as Freddie Mac's and Fannie Mae's have drastically cut the time needed for a loan applicant to get a decision - from days or weeks to seconds.

On the other hand, these lightning-quick credit evaluations frequently leave applicants in the dark. They may be accepted for funding, but because their credit scores don't meet minimum benchmarks set by the underwriting software's statistical models, they are charged higher rates or fees. Those higher charges, however, qualify as "adverse actions" under the federal fair-credit law, say consumer advocates. Yet consumers rarely get to review the credit data that triggered the adverse action.

Worse, says Edmund Mierzwinski, consumer program director at the Washington-based Public Interest Research Group, the underlying data in the credit files are often inaccurate or incomplete. One-third of all credit files in a study by Mierzwinski's group contained errors "sufficient to lower the applicant's credit score" enough to affect a lending decision.

Richard Le Febvre, chief executive of AAA American Credit Bureau of Flagstaff, Ariz., says electronic underwriting has "eliminated the safety net" that the fair-credit law once guaranteed. When an underwriting decision flashes across a computer screen, "almost nobody takes the time anymore" to review the applicant's files, looking for errors, as often occurred in the pre-electronic, slower-paced underwriting era, says Le Febvre.

Kenneth R. Harney is a syndicated columnist. His e-mail address is Send letters care of The Washington Post Writers Group, 1150 15th St. N.W., Washington 20071.

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