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Are your fair lending practices evolving with the times?

Sep 21, 2022

Fair lending requirements have come a long way since the first law, the Fair Housing Act (FHA), was introduced 54 years ago. The FHA was created to ensure access to housing for people who belong to certain protected classes. Its goal was to prohibit discrimination based on seven factors: color, disability, familial status, national origin, race, religion and sex. The law applies to lenders, landlords, sellers, appraisers and others involved in buying or renting housing.

Lending discrimination happens when a lender bases a credit decision on factors other than a borrower’s creditworthiness. As a follow-up to the FHA, the Equal Credit Opportunity Act (ECOA), passed in 1974, explicitly prohibited discrimination in lending.

The ECOA made it illegal for creditors to discriminate based on race, color, religion, national origin, sex, marital status, age (provided the applicant has the capacity to contract), the fact that the applicant’s income is derived from any public assistance program, or that the applicant exercised, in good faith, any right under the Consumer Credit Protection Act.

Two other laws, the Community Reinvestment Act (CRA) and Home Mortgage Disclosure Act (HMDA) both play additional roles in strengthening fair lending enforcement.

Under the ECOA and FHA, discrimination can occur at any point in the credit process and can involve any credit product or delivery system. The rules apply to marketing, the application process, pricing, underwriting, servicing and collections.

Methods of proof

The courts have recognized three methods of proof of lending discrimination:

  • Overt evidence of disparate treatment
  • Comparative evidence of disparate treatment
  • Evidence of disparate impact

So, what is the difference between disparate treatment and disparate impact?  Disparate treatment results when applicants are treated differently and there is no other explanation for the difference in treatment other than that they are part of a prohibited basis group, while disparate impact is a neutral policy applied equally to everyone, but the effect of the policy or practice disproportionately excludes or burdens persons on a prohibited basis.

Fair lending can touch every area of the financial institution. Much of the time, violations that occur are unintentional. Addressing these questions can help raise your awareness of practices or policies that run afoul of the law:

  • Is there anything on your website or in your marketing materials that could discourage someone within a prohibited basis group from seeking a loan from you? Images in your marketing that don’t represent all protected classes or messages that suggest houses or cars might not be attainable by people in certain groups could become a legal issue.
  • Have you ever tested for disparities in the time involved to process a mortgage application, interest rates and fees, and denial rates between those in protected classes and those who are not? How does your response time for applicants in majority minority areas compare to those from other areas? This data is helpful in determining whether there is an appearance of disparate treatment or impact.
  • Have you reviewed how you handle policy and pricing exceptions? Are you documenting the mitigating circumstances, analyzing the exceptions for fair lending implications, and presenting those exceptions to the board or committee of the board for review? Considering who was granted exceptions, and who was not, is helpful in determining how consistently your credit practices are applied between all borrower groups.

Redlining persists

Lately, potential racial bias in redlining practices is receiving renewed attention. Redlining has shifted away from using maps with a red circle highlighting communities where service was denied, to decisions about where loan officers are placed, where products are offered and where marketing efforts are focused.

Digital redlining is a current focus of the Consumer Financial Protection Bureau (CFPB). Academic studies are raising questions about algorithmic bias. CFPB director Rohit Chopra stated in a recent speech that a statistical analysis of two million mortgage applications found that black families were 80% more likely to be denied by an algorithm when compared to white families with similar financial and credit backgrounds. These “black box” algorithms can result in redlining by excluding borrowers who live in specified areas.

Chopra noted that mortgage companies conceded that their researchers don’t have all the needed data that feeds into the algorithms or full knowledge of how they work. The algorithms were compared to black boxes behind a brick wall.

When consumers and regulators do not know how the decisioning is being made by the algorithms, the consumer is not able to actively participate in a fair and competitive market free from bias. If you are using an automated underwriting system, do you understand how the system is making decisions, or is it a black box behind a brick wall?

Scrutiny of appraisals

Racial bias in appraisals has also made recent headlines. A study from the Federal Home Loan Mortgage Corporation (Freddie Mac) found that the appraisal industry was consistently undervaluing homes located in predominantly minority (Black and Latino) tracts compared to those in predominantly white tracts. On average, homes in Black and Latino neighborhoods appeared to have been valued as much as 23% lower on average than similar homes in predominately white neighborhoods.

When reviewing appraisals, the reviewer should be looking at the selection of comparables, adjustments made to the comparables, and appraiser opinions in the reconciliation of the value.

While fair lending requirements are not new, much work remains to be done to ensure compliance. Fair lending is a critical priority for financial institutions, and technology has led to evolving concerns about violations and enforcement measures.

How Wipfli can help

It’s essential for financial institutions to keep up with the changes affecting fair lending practices. Wipfli professionals can review your program and procedures through a compliance lens. Ensuring you are providing equal access to financing is not only the right thing to do for your customers but also a matter of law. Wipfli can assist you with your fair lending practices and help you reduce risk. Learn more about our compliance services for financial institutions.

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Kristen L. Eustis, CRCM
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