New Bill Prohibits Pre-Employment Credit Checks

A newly proposed bill would stop pre-employment credit checks on non-security related jobs.

Last week, Senator Elizabeth Warren (D-Mass.) announced The Equal Employment for All Act, which would amend the Fair Credit Reporting Act and thereby stop employers from requiring an applicant’s credit history. The proposed bill would also prohibit employers from disqualifying employees based on a poor credit rating or other information dealing with the applicant’s creditworthiness. The only employment exemption is with positions that require national security clearance.

Keith Newcomb, portfolio manager for Full Life Financial, said the bill would strike a blow for fairness in employment practices and would have an “overwhelmingly positive” impact on applicants.

But he said that certain sectors, especially financial and security organizations that demand high personal trust and accountability will put up serious resistance to the bill since they’ll effectively be prohibited from detecting issues of character that may later adversely affect their organizations.

Bennie Waller, a professor of finance and real estate at Longwood University, also believes that certain professions should keep the rigid standards. He said that credit reports are a very good measure of risk.

Waller said that if he hired in the financial sector, he would want to employ the best person for the opening. If two applicants are equal on paper, but one has a credit score of 500 and the other has a credit score of 750, the higher credit score likely alludes to a better financial responsibility.

Even though Waller would prefer a higher credit score, he admitted that many uncontrollable items or situations can negatively impact a consumer’s history such as a rocky divorce.

“We’ve all made mistakes in our personal lives,” he said. “We would like to keep it in our personal lives and not go into our professional lives.”

If an applicant has a lower credit score, Waller said it is important to be open about it to the hiring manager and explain the situation. In his opinion, one or two mistakes is not enough to tarnish a “good” work history.

The potential power of Warren’s bill could have a tangible impact on the nation’s citizens, such as James August, a 25-year-old resident of Cleveland, Ohio, who has been job searching unsuccessfully for the past year.

August says that he was required to submit his credit information for the majority of his employment applications. Although he has not been specifically told that his credit prevented employment, he doesn’t believe it played a substantial part.

Despite graduating college, August has been unable to find full-time employment or a job that pays more than minimum wage. He soon found himself unable to repay his student loans on time and defaulted.

Student loan debt is the main item on August’s credit report due to him having no other forms of credit. His low score and his inability to repay his debts has trapped him in a vicious cycle.

“The more my credit score drops, the less likely I’ll be able to get a job,” he said. And without a job, he has little chance of repaying his college loans and fixing his credit.

Although he is personally impacted by hiring managers pulling applicants’ credit scores, August is able to see why it such reports are used so frequently. Employers look for qualitative aspects such as how applicants work with others, their ability to work in fast-paced environments and their levels of expertise. When a resume is not enough, a credit history details another side of an applicant.

But the one-sided nature of credit reports can hide the actual cause of debt or financial woes. As Waller detailed, low credit scores can be caused by unexpected events and not just because of poor financial decisions.

Senator Warren stated that the bill was created partly due to research which shows that an individual’s credit rating has little to no correlation of his or her workplace success.

“A bad credit rating is far more often the result of unexpected medical costs, unemployment, economic downturns, or other bad breaks than it is a reflection on any individual’s character or abilities,” Senator Warren said in a statement.

Warren worries that many consumers are still recovering from the 2008 financial crisis and searching for a stable job is part of this process.

“This is about basic fairness — let people compete on the merits, not on whether they already have enough money to pay all their bills,” she said.

When applicants are judged on something so ever-present as a credit score, discrimination can occur easily. August said that some applicants ruin their employment chances without lifting a finger.

“For our capitalistic society, financial well-being plays such a large role of determining our personal lives and placement in society,” he said. “It’s the categorizing of people in such a way that removes the human aspect of that person — that makes the practice discriminatory.”

August believes that efforts such as Warren’s bill could reduce the likelihood of employer discrimination. The damage caused by the Great Recession could reduce further and create more workplace equality, a place where employees are not judged by their personal loan debt but rather by their willingness to work.

“Perhaps the employers can begin to look beyond what numbers are equated with people and care more about who they are and what they have done,” he said. 


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CFPB Rules Reiterate Current and Future Lending Practices

New mortgage loan rules beginning on Jan. 10, 2014 could limit the current availability and cost of mortgage loans but experts state that the real impact is in the long-term.

The new lending rules are an amendment of Regulation Z of the Dodd-Frank Act. According to the Consumer Financial Protection Bureau, lenders must confirm that a borrower’s debt-to-income ratio is less than 43 percent.

In addition to the DTI ratios, lenders must also request and verify a borrower’s ability-to-repay via eight different categories:

  1. Current income or assets
  2. Current employment status
  3. Credit history
  4. Monthly mortgage payment for current loan
  5. Monthly payments for other mortgage loans
  6. Monthly payments for mortgage-related expenses
  7. Other debts
  8. Overall monthly debt payments including a debt-to-income ratio

The new rules could prevent some homeowners from gaining approval on a mortgage loan, but without the protections of these new rules, those homeowners would have likely received unfavorable lending terms.

Leading up to the housing crash, many borrowers put too much faith in lenders, relying on the underwriters to decide if they could actually afford and repay the mortgage debt. The lax standards during the early- and mid-2000s forced millions of loans into default or underwater status.

In the aftermath of the housing bubble burst, most lenders quickly enacted their own lending standards and required similar information verification for new mortgage loans. The current CFPB amendment is simply a reiteration of guidelines enacted after the housing crash by the main lenders, according to Tim Lucas, editor-in-chief of mymortgageinsider.com.

“After 2008, lenders did away with non-verified loans,” he said. “So in that way, the ability-to-repay rule is beating a horse that died long ago.”

Lucas said there could be a tangible financial impact of the rules. He said that buying a home in large cities could become more expensive. But for other areas with low home prices and high incomes, such as Texas, the lending market should proceed in a normal fashion.

The other component of the rule, the 43 percent debt-to-income ratio, could also have an impact on many consumers that take on large debts but are able to repay on time.

In 2006 and 2007, Lucas regularly approved borrowers with DTIs of 55 percent and even 65 percent. Despite the high numbers, he insists that the loans were not subprime and were allowable under Freddie Mac’s lending guidelines.

He is surprised that the debt cap was set at 43 percent instead of a higher figure.

“While debt ratios this high were arguably a bit excessive, there were usually compensating factors that made up for the high DTI,” he said. “Usually the borrower had great credit and a lot of money in the bank.”

Lucas predicts that retired consumers stand to be hit the hardest due to their limited monthly income.

FHA loan borrowers are able to avoid the DTI limit and apply for larger loans. Lucas said this exemption will push more new home loans into the more expensive FHA loan territory.

Aside from the FHA’s products rising in demand, David Reiss, professor of law at the Brooklyn Law School, said there could be other long-term effects due to this high DTI ratio since the lending rules will likely remain for several decades.

If the rules remain intact, the high DTI number can still be lowered at a later time. For instance, if few defaults occur when the bar is set at 43 percent, the limit might increase. Conversely, if a large number of defaults occur, the limit will decrease even further.

Reiss hopes that the agencies overseeing the rule will make these changes based on empirical evidence.

“I’m hopeful that regulation in this area will be numbers driven,” he said.

Despite the wording, Bill Parker, senior loan officer at Gencor Mortgage, said that lenders are technically “not required to ensure borrowers can repay their loans.” He said lenders are legally required to make a “good faith effort” for reviewing documents and facts about the borrower and indicating if he or she can repay the debt.

“If they do so, following the directives of the CFPB, then they are protected against suit by said borrower in the future,” Parker said. “If they can’t prove they investigated as required, then they lose the Safe Harbor and have to prove the borrower has not suffered harm because of this.”

The statute of limitations for the CFPB law is three years from the start of loan payments. After that time period, the lender is no longer required to provide evidence of loan compliance.

Even though the amendment could impact the current lending market, experts told loans.org that the CFPB’s standards will make a greater impact on the future of the housing industry.

Reiss believes that the stricter rules will create a sustainable lending market.

Lucas agrees and thinks of the rules as more preventative measures.

“The idea was to put a fence at the edge of a cliff so lenders would not eventually fall off again,” he said.

Although the thought of approving a loan without income verification sounds ludicrous now, it was not always this way. Lending rules and debt caps were common in the 1990’s, but as the new millennium began, the rules became less common. The CFPB’s rules ensure that future mortgage lending is protected.

“History teaches us that as time goes by we really don’t learn from our mistakes,” Lucas said.


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CFPB Fights Auto Loan Lenders and Dealers Over Dealer Reserve

The CFPB is gearing up to change lending rules for auto loan lenders in 2014.

The Bureau alleges that dealer reserve, which is a kickback dealerships receive for charging consumer’s higher interest rates on auto loans, is little more than a ripoff to consumers.

In place of this, the CFPB wants to create a flat fee policy that would replace dealer reserve and also prevent lending discrimination.

Senator Elizabeth Warren (D-MA) is one of the strongest voices calling for auto loan rule changes, having stated in the past that auto loan borrowers are tricked out of billions of dollars each year.

In response to this, the National Automobile Dealers Association (NADA) has countered that the CFPB has not revealed how it even knows that discrimination is occurring in the auto loan market. Additionally, NADA states that it fully supports the nation’s fair lending laws and is committed to working with federal agencies to eliminate discrimination in the marketplace.

Bailey Wood, Spokesperson for NADA, expanded on the organization’s statements and defended the practice of dealer reserve.

“Our perspective is that dealer reserve increases access to credit,” he said. “Dealers have the ability to meet or beat a bank’s interest rate. If Warren has her way, the ability of dealers to discount loans would be gone. What the Senator wants to do is eliminate 17,000 auto loan discounters from the marketplace.”

Wood explained that indirect-financing helps consumers by offering increased competition between lenders. This is because dealers are able to access lenders that the general public is unable to get to. Since different lenders try to outbid each other, they push the price down for consumers.

“On average, we’ve looked at actual transactional data, the average customer saves 0.7 percent on a used car loan and a whole percentage point on a new car loan,” said Wood.

Should the CFPB end interest rate competition, he fears that consumers would ultimately suffer, not dealerships.

“What a consumer pays is going to go up dramatically,” he said. “If you reduce competition, prices go up. People are not gonna be able to negotiate a lower interest rate.”

Wood pointed out that car buyers can already walk into dealerships with financing in hand, such as from a credit union or bank. With this financing, they have a bargaining chip to hold over a salesman’s head and push for a lower interest rate. Some dealerships will try to beat the financing that a customer walked in with in order to gain the customer’s business. Wood himself purchased a vehicle in the Summer and after showing a dealership the financing he walked in with, the dealership beat it by one whole percentage point. 

As far as the CFPB’s flat fee concept that would supposedly end discrimination in auto loan lending, Wood is far from optimistic.

“Dealers will go with whoever has the highest flat fee,” he said. “Right now consumers can negotiate better interest rate than if a flat fee existed.”

One expert with a history working in car dealerships couldn’t disagree more.

Brian Massie, a Communication Consultant and former Ford Salesperson, said that ending dealer reserve is a good idea.

“The Finance and Insurance Department of a dealership is where a lot of the money is made because of the lack of consumer information,” said Massie. “That being said, these practices are due in part to the forced disclosure about all other financial aspects of a vehicle purchase transaction. One cannot, for example, walk into a furniture store armed with all information pertaining to how much the store paid for the items on display. For some reason, people are able to do that with automobiles.”

Massie qualified his remarks by stating that he is supportive of full disclosure in lending but against full disclosure of dealership pricing. He postulates that if dealer reserve is eliminated, it will reduce the amount of predatory lending practices by primarily smaller dealerships who need to make every penny possible off every sale since they do not do the sales volume needed to generate a strong net bottom line.

“Those dealers who do not participate in this practice will not be initially affected but in time they will see a benefit as other dealers close and reduce competition,” said Massie. “It is up to the consumer to decide if they are better off with more disclosure at the expense of less competition.”

However, the threat of imposing flat fees upon dealerships in place of dealer reserve is something that trade groups like NADA fear.

“On its surface, a flat fee sounds like a good idea,” said Massie. “However, due to cost of living differences depending on a given area, the effect wouldn’t be uniform. Thus I don’t think it would be the best idea.”

Massie explained that dealers are trained to “take the rebate, skip the lower rate” by explaining to customers that by taking the rebate they are financing less money and not facing any early payment penalties on their auto loans. Any consumer who complains about offered interest rates is told that they can try to work with a bank or credit union to get a better deal to beat the dealership’s offer.

“Car dealerships are like mortgage brokers in that, once the loan has been created it is an asset,” said Massie. “The dealership gets paid a commission from the finance company for closing the deal and creating that asset.  People are often under the assumption they can’t make a different deal with another lending institution once they locked in with a given finance company.  But, just like in the case of a homeowner, any auto loan be refinanced.”

Regarding the CFPB’s allegations of discrimination, Massie believes that the only color dealerships care about is the color green.

“During my time as a salesperson I never knew of any discriminatory practice to take place,” said Massie. “If one buyer has an advantage over another buyer, financial resources being equal, the better informed consumer will always spend less.” 

New Rules, New Problems

Rob Drury, Executive Director of the Association of Christian Financial Advisors, said that the CFPB’s allegations of discrimination are completely unfounded and that the CFPB’s plans might end up making it harder to buy a car.

“First of all, auto financing is simply a consumer good and the market is fiercely competitive,” said Drury. “Loans are bought on a wholesale basis and sold at retail, just like any other product. The appropriate price is determined by the required profit margins of the wholesale and retail entities, and by the customer’s ability and willingness to shop. The two percent cap that many lenders place on dealer markup is extremely reasonable and sufficient to prevent abuse concerns, but is truly only there to maintain the reputation of the lender; a shining example of the market effectively and efficiently regulating itself.”

Even though most dealerships keep their rates fair and reasonable in order to sell more cars, if dealerships cannot depend on revenue from financing, they are less likely to sell cars if they can’t make money on car loans.

“One cannot be denied an opportunity based upon a legally protected criterion if that criterion was not part of the decision process,” said Drury. “Also, it makes absolutely no sense that a dealership would take the substantial steps necessary to sell an individual a vehicle, then take further steps to prohibit that sale from taking place.”

While observers are quick to point out that a dealership has little to do with the CFPB’s oversight or sphere of influence, the lenders and financial companies responsible for auto loan lending do.

“Granted, only the lenders in the dealership scenario are regulated by the CFPB, but the policies under which dealership can offer financing are controlled entirely by the lender, and therefore effectively fall under the CFPB’s scrutiny,” said Drury. “It would seem reasonable that the lender would be sensitive to dealers’ concerns, as dealer financing is an extremely important marketing venue for most auto lenders.”

Assuming the CFPB eliminates dealer reserve, dealers would lose a critical piece of revenue generation and would have little incentive to offer occasional deals. Customers would also lose financing options as unprofitable auto loan lenders dissolve.

“Elizabeth Warren has consistently shown a disdain for business, and it would appear that nothing in her vision of the CFPB is designed to better the business environment,” said Drury. “She has no grasp of the fact that what is bad for businesses is almost always bad for the consumer as well. The customary two percent cap on dealer reserve is extremely reasonable, and has no significant effect on the buyer in the purchase of a vehicle. It can, however, make or break the possibility of a car deal.”


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TransUnion Predicts Auto Loan Lending and Delinquency Rise in 2014

According to a TransUnion report, 2014 will be a year of increases in both auto loan lending and payment delinquencies.

The average automotive debt per borrower is expected to increase from a 2013 figure of $16,942 to a 2014 figure of $17,966.

Auto loans that are 60 days or more past due are expected to increase from 1.1 to 1.19 percent. However, this is still below the delinquency peak of 1.59 percent in Q4 2008.

The report also highlighted how auto loan lending has been on a positive trend since Q4 2010.

Borrowers with subprime credit scores made up 29.8 percent of all auto loans in the third quarter of 2013, while in 2008 borrowers with subprime credit accounted for 34.6 percent in 2008.

Peter Turek, Automotive Vice President in TransUnion’s Financial Services Business Unit, wasn’t intimidated by the uptick in delinquencies.

“While we expect auto loan delinquencies to rise in 2014, they will remain well below levels observed during the recession and its immediate aftermath,” he said in the report. “One of the primary drivers for low delinquency rates is the strength of the used car market; borrowers who cannot afford their car loan payments usually have the option of selling the car and becoming whole on the loan.”

Necessity, Consumer Confidence, Financial Amnesia, and Lenders

Gail Cunningham, Vice President of Membership and Public Relations at the National Foundation for Credit Counseling said that there are four main reasons why delinquencies and lending will increase in 2014: necessity, consumer confidence, financial amnesia, and lenders.

The first reason, necessity, simply means that consumers and drivers have no other option but to purchase another vehicle. In order to purchase a vehicle, they often need an auto loan.

“Perhaps people have held off spending, certainly on major purchases, as long as they can,” said Cunningham. “There was an uptick in vehicle purchasing that began last year, and apparently is forecasted to continue. I haven’t looked up the age of the average car on the road, but it’s always older than I would have thought.  Therefore, people may legitimately need a new vehicle.”

The second reason, consumer confidence, is clearly reflective of the economy.

While the stock market has rebounded and many other people have gained wealth as foreign wars have wound down, there is a sense of stability in the air. As a result, people are more willing to make a major purchase, such as an automobile, especially if they have paid down their debts. Of course, cars are also an integral part of the American dream and the American sense of independence.

Financial amnesia, the third reason, is more of an ill omen for consumers.

“This is what I’m calling prematurely forgetting the sins and the pain of the past,” said Cunningham. “Americans are a hopeful lot of people, preferring to think that things will work out well.  That’s a nice trait to have unless it involves ignoring the financial facts.”

The fourth and final reason, lenders themselves, begs the question of whether or not many of these new auto loans being lent out are being responsibly underwritten.

“They have extended the term of a vehicle loan in order to make the monthly payments more affordable, but if delinquencies are high in spite of that, it becomes obvious that the loans are not sustainable,” said Cunningham. “Could they, too, have a case of financial amnesia?”


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