ACTION AUDIT: Selecting Reasons For Adverse Action

Regulation B tells creditors that they must inform credit applicants of the specific reasons for denial. This requirement is not new. It has been in place for a quarter of a century. But we still have trouble with it.

Not every lender - or clerk to whom the assignment is given - is adept at identifying specific reasons for denial. Lenders sometimes simply "know" that the borrower isn't creditworthy and a specific reason doesn't jump out. (When this is the case, the loan officer has to think harder until they diagnose just how they know this.) Clerks have difficulty knowing what the loan officer was thinking unless the loan officer writes it down - clearly.

There are also situations where the reasons themselves seem ambiguous - especially in the way they are used. A favorite of examiners is a notice that says "insufficient collateral" when the customer applied for unsecured credit. How is the collateral insufficient when there wasn't supposed to be any? Loan officers generally come up with a lame-sounding explanation that with such a marginal credit history, they would want the customer to have or to offer collateral. This explanation doesn't fly. In fact, it crashes and burns.

Then there are the multi-phase decision-making processes. Most popular of these is using a credit score as a first step followed by judgmental review. When the application is denied, how should the lender identify the reasons?

Finally, the reasons should be "specific." This means that the explanation given to the customer has to be clear enough and sufficiently precise for the customer to understand. No gobbeldy-gook allowed.In identifying reasons for adverse action, the lender should focus on what attributes of the applicant really drove the decision process. Ask how and why the application failed. Here are some guidelines.

How To Select "Specific Reasons" For Adverse Action

The reason given to the applicant has to answer the applicant's question "why was my application denied?" If it doesn't answer this question, it isn't specific.
The reason given to the applicant must be related to the credit request. Don't give an answer that wasn't relevant to the original request, such as "insufficient collateral" for an application for unsecured credit. If the customer's assets become a concern, the lender should consider why, and give that as the reason(s).
The reason given to the applicant must be understandable to the applicant. Avoid banking terminology and special acronyms. Customers should not be expected to know what a loan officer knows. Besides, if the reasons are in clear language, you are less likely to get questions about them from confused consumers. Save yourself some time and make it understandable.
Give as many reasons as it takes. Applicants may have one weakness or many. The applicant should know about every weakness (up to four) in the application that caused denial. Otherwise, the applicant is likely to think that an unmentioned weakness was not actually a weakness.

How To Select Reasons From Multiple Phase Decisions

If the applicant fails the credit score phase and the application is denied, the reasons given should all come from the credit scoring system. If the score is purchased from a credit bureau, be sure to also purchase the reasons so you can pass these on to the applicant in your adverse action notice.
If the applicant easily passes the credit score but fails the judgmental review, the reasons should be selected from the judgmental portion of the review.
If the applicant has a borderline score, and also fails under judgmental review, the reasons given to the applicant should be from both phases of evaluation. One or more reasons should come from the credit scoring system and one or more reasons should come from the judgmental review.
If the applicant's score triggers additional judgmental review, the reasons for adverse action selected from the scoring system should be those reasons contributing the most to the low score.
Some reasons, such as irregular payments shown in the credit history, may be considered in both phases of the review. An irregular payment history on large balance loans such as a mortgage or a car loan would lower the credit score and could also be considered insurmountable in the judgmental review. In that case, the reason taken from each system, will be the same reason.