In a potentially far-reaching decision, a federal court last week denied mortgage investor Freddie Mac’s motion to dismiss a nationl class action suit that claims the company systematically violated the rights of hundreds of thousands of home mortgage borrowers.

The denial was handed down last Wednesday by the U.S. District Court for the Eastern District of Pennsylavania. The suit, filed late last year, alleges that Freddie Mac has failed to provide the “adverse action” notices required by the federal Fair Credit Reporting Act, and asks for substantial monetary damages on behalf of all home loan applicants rejected or charged higher interest rates through Freddie Mac’s electronic Loan Prospector underwriting system during the past two years.

The principal attorney for the plaintiffs, James Francis, told Realty Times that the court’s ruling opens the way to the legal discovery process--allowing Freddie Mac’s use of credit file data to be examined by the complainants. The lead plaintiff in the case is Donald Weidman, a Philadelphia home owner who applied for a mortgage last year through several lenders, each of whom used Freddie Mac’s electronic system to deny his applications.

The Loan Prospector system permits lenders in all 50 states to submit application data and receive a funding and pricing decision--Freddie Mac’s willingness to buy the loan--within a couple of minutes. Though the inner workings of Loan Prospector are closely-held proprietary secrets, sources at Freddie Mac have confirmed that the system pulls consumers’ credit file data directly from the three national repositories--Equifax, Experian and Trans Union. Once the credit data is on hand electronically, the system runs the files through statistical models designed to predict future risk of default by the applicant.

Borrowers who present higher than standard credit risk are not rejected out of hand, but are either quoted higher rates or issued “cautions” requiring additional investigation by the loan officer handling the application. As a practical matter, some loan officers treat Freddie Mac’s “cautions” as the functional equivalent of turndowns, and do not pursue additional loan products for the borrower.

Weidman charges that he was denied credit because of Freddie’s system, but never recieved the legally required notices of the “adverse actions” taken. Under the law, lenders, landlords and others who obtain and use credit reports and scores to make decisions on consumers’ applications are required to provide a formal adverse action notice. That notice explains precisely what adverse action was taken, and identifies the credit reporting agencies whose information contributed to the rejection or higher interest rate quote.

Weidman’s suit charges that although Freddie Mac is subject to the Fair Credit Reporting Act, it never provided him any explanation of the specific sources of credit information that led to his rejections, nor afforded him an opportunity to review the credit file data involved.Consumer advocates say Weidman’s suit is significant because many loan applicants get rejected--or priced to higher-cost loan products--because of erroneous information in their credit files. Last December a national study of over 502,000 consumer credit files conducted by the Consumer Federation of America and the National Credit Reporting Association documented “massive inaccuracies” and missing data in Americans’ credit files. The errors and omissions put as many as 40 million consumers at risk of being rejected--or overcharged--on applications for credit as the result of bad data in their files, according to the study.

“If you don’t get an adverse action notice,” said litigator Francis, “how are you supposed to know to challenge the inaccuracies in the credit files” that led to the denial or up-pricing?

A Freddie Mac spokeswoman said the corporation had anticipated the denial of its dismissal motion, and maintains its position that its electronic underwriting system does not violate the fair credit law.

Published: March 24, 2003

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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.