Applying for a Loan While Challenging a Trade Line

There is a little-known and controversial practice by mortgage giants Fannie Mae and Freddie Mac,( the people who financially back the home loan industry) that will stop your next home loan application right in its’ tracks.

Let’s look at an example:  You have great scores:  in the 780 range.  You have great equity in your home.  You want to refinance your home to send your child to college.  You have been on the job for 20 years and have more than enough income.  The rates are great.

But your bank says: Sorry. We can't do your loan.   Why?  What the ……………………………

Fannie Mae's automated underwriting system won't accept any application in which there is a notation in the credit report that a consumer has disputed an account or "trade line."

You explain that the dispute –it was over a medical bill --was valid. The account was closed. The creditor promised to remove the dispute notation but apparently never did. Your loan officer won't budge. Policy is policy, he says. Your refi application is dead.

What's going on here? Under the Fair Credit Reporting Act, you have the right to dispute erroneous information on any account in your file. Once you challenge that information, a notation to this effect must be made on the file. As long as it remains, most credit scoring systems generally will not factor the disputed account into the computation of the consumer's score.   Thus, the potential creditor does not receive an accurate reflection of the real score.

Does Fannie Mae deny loans to consumers simply because they exercised their legal rights?

Fannie Mae’s and Freddie Mac’s automated underwriting systems -- used by virtually all lenders doing business -- sends applications with "consumer disputed" items on credit reports back to the lender for what is known as "manual underwriting."

Freddie Mac and Fannie Mae do not prohibit delivery of a loan . . . where the borrower has disputed information" on his or her credit report. Their underwriting requires the lender to determine and document whether or not the disputed information is accurate and underwrite the borrower's credit accordingly.  Problem is, the lenders typically will not manually underwrite because then they have the liability if the loan goes into default.

When trade lines in a consumer's file contain a "disputed" notation, most scoring software ignores them for the purposes of computing the score.

A seriously delinquent account that could legitimately depress a FICO score might be taken out of the equation -- at least temporarily -- if a "consumer-disputed" notation is in the file. Fannie and Freddie are trying to protect themselves from gamesters and frauds.

But what about the impact on disputed items when the consumer is right -- or files in which creditors failed to remove the disputed-account designation? For the time being, it's tough luck for all applicants with disputes in their credit files.