Do trial attorneys have the country's two biggest--and richest--sources of home mortgage money in their gunsights?

A new class action suit filed last week against Freddie Mac--on the heels of a major class action against Fannie Mae--suggests that the answer is yes. And consumer law specialists say even more suits against the two mortgage giants' electronic underwriting practices are just over the horizon.

The suit against Freddie Mac, filed last week in U.S. District Court in Philadelphia, attacks the company's automated underwritng system, which is used to evaluate loan applications made by millions of new home buyers and refinancers per year.

The suit alleges that Freddie Mac's "Loan Prospector" system violates the federal Fair Credit Reporting Act by failing to advise certain borrowers that their interest rate quotes are higher than standard because of problems detected in their credit files. The "class" of borrowers negatively affected by Freddie Mac's alleged violations numbers in the "hundreds of thousands" or millions, according to the suit.

Freddie Mac's proprietary Loan Prospector system is widely used by lenders and brokers nationwide to analyze loan applications. The system allows loan officers to submit basic borrower data online--including Social Security numbers, income and debt ratios--and receive a report within seconds or minutes from Freddie Mac detailing the interest rate and other terms upon which the company would purchase the applicant's loan.

Loan Prospector pulls full credit file information instantaneously from the three giant national credit repositiories--Equifax, Experian and Trans Union--as well as electronic property valuation information. If the system rates an applicant as higher risk than optimal, Freddie Mac may propose purchasing the loan at a higher interest rate or require a larger downpayment, or deeper mortgage insurance coverage.

That practice, charges the suit by Philadelpia home owner Donald Weidman, triggers disclosure responsibilities under the Fair Credit Reporting Act, but Freddie Mac does not comply. Under the statute, lenders, landlords and others who use credit file information to evaluate and price consumer applications, must inform the applicant whenever an "adverse action" occurs.

Consumers charged higher rates--or rejected--must be told the names and addresses of all credit information sources used in reaching the adverse conclusion. Applicants can then review the credit information for inaccuracies and refile the application.

Weidman's suit charges that Freddie Mac's automated underwriting system provides no disclosure or notice to mortgage applicants who are quoted higher rates or inferior terms because of Loan Prospector's credit file evalutions.

Freddie Mac officials were still reviewing the suit late last when contacted for comment by RealtyTimes. But spokeswoman Sharon McHale said that "we are confident that Freddie Mac is in full compliance with the statute, and we intend to defend ourselves vigorously."

Weidman charged that he applied last year for a home mortgage at several lending institutions, each of whom used the Freddie Mac system to turn him down or charge him higher than standard rates and terms.Yet, says the suit, Freddie Mac never provided Weidman with the fair credit disclosures guaranteed him under federal law. Weidman's "class" of similarly-affected applicants--borrowers who would receive monetary damages if the suit is successful--includes all mortgage applicants who were quoted a higher rate or rejected through Freddie Mac's Loan Prospector system during the past two years.

Consumer advocates and federal regulators declined comment on the specifics of the suit until they have an opportunity to review the case. But Edmund Mierzwinski of Washington DC-based Public Interest Research Group says the Freddie Mac suit is just a hint of suits to come.

"There is a broad exposure in the home mortgage lending industry" to legal challenges over non-compliance with the Fair Credit Reporting Act, he said. "It is fundamental under the law that you are supposed to give loan applicants the right to see the credit report information whenever they are asked to pay more for credit or are rejected. But with automated underwriting, that doesn't happen' in most cases, said Mierzwinski.

A long-time critic of electronic underwiting from within the credit industry, Richard LeFebvre of AAA Credit of Flagstaff, Arizona, says Freddie Mac's and Fannie Mae's systems amount to "automated undermining of consumers' rights" and use credit bureau data "that is often erroneous or out of date."

Published: October 28, 2002

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consmer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.