A long-simmering consumer issue in the mortgage market is getting fresh attention on Capitol Hill: Are large numbers of unsuspecting home buyers being charged more than they should on their mortgages because an electronic underwriting system used erroneous or incomplete credit bureau information?

Consumer and credit industry witnesses at a House Financial Services subcommittee hearing made strong arguments that such mis-pricing is a commonplace occurrence under today's lightning-fast electronic mortgage approval systems.

The systems--the largest of which are installed at Fannie Mae, Freddie Mac, and at some national mortgage banking companies--essentially allow a loan oficer or broker anywhere in the country to obtain an instantaneous quote for a mortgage applicant. The loan officer submits the applicant's name, address, Social Security number and property data to a central computer system. Within one to two minutes, the loan officer gets back a funding decision and a rate quote representing the financial institution's willingness to purchase the loan at a specified price.

In order to make the quote, the system does an online check of the applicant's credit files and assigns an internal credit-risk score calibrated to the institution's current range of rates. For instance, an applicant whose credit files included--whether accurately or inaccurately--reports of late payments or nonpayments, might be quoted a rate anywhere from 1/4 of a percentage point to 1 1/2 percentage points above the best rate currently offered by the lending institution.

But what if the credit data in the files isn't correct? Does the applicant get a chance to look at the credit files or to dispute the inaccuracies? Equally important, does the applicant even know that he or she is being charged 1/4 or 1/2 a point higher rate because of undisclosed bad data?

Consumer witnesses at the House hearing on the federal Fair Credit Reporting Act said that all too often, the answers to these questions is no. Shanna Smith, CEO of the National Fair Housing Alliance, told committee members that electronic systems frequently facilitate subtle overcharges of mortgage applicants behind their backs.

When one of the systems flags an applicant as having credit problems, she said, the loan officer is supposed to "manually underwrite" the mortgage. That means the loan officer should take the credit data, show it to the applicant, and determine whether errors or omissions are affecting the credit rating.

But that's not what happens in many cases in today's fast-paced market, charged Smith. "From interviews with hundreds of loan originators over the past five years," Smith told the committee, "I have learned that at least half of the loan (officers) will send the applicant to a subprime (high rate) lender, rather than spend the time necessary to manually underwrite the loan."

Manual, old-fashioned, face-to-face underwriting can help detect--and correct--credit file errors, said Smith. But when computer decisions and pricing are all that the mortgage loan officer uses, credit-impaired applicants either get hit with high rates they may not deserve, or get railroaded to high-cost loan originators.

Another witness at the House hearings, a credit agency CEO--Richard LeFebvre of AAA American Credit Bureau of Flagstaff, AZ--said such behavior by loan officers violates the Fair Credit Reporting Act. That statute guarantees consumers the right to receive an "adverse action" notice anytime credit file information causes them financial harm in any way, including being pushed into a higher-rate mortgage.

Electronic underwriting systems--with their "risk-based pricing" rate quote engines--are "used to surcharge" borrowers unfairly, said LeFebvre, "by not giving consumers their 'mandatory' adverse action notices."

Congress is expected to consider amendments to the Fair Credit Reporting Act this year, at least one of which could require loan officers to review negative credit data with applicants to ensure that risk-based computer-pricing decisions are correct.

The upshot for you as a loan applicant, or as a real estate professional advising a home buyer? If the rate quote and funding decision were made by an electronic pricing system, ask the loan officer whether credit data raised the quote, even slightly. If it did, demand an adverse action notice under the fair credit law, and manually review the credit file data that produced the higher charge. It could save you tens of thousands of dollars over the life of your mortgage.

Published: June 23, 2003

Use of this article without permission is a violation of federal copyright laws.

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.