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Disparate Impact, Fair Lending and the CFPB-Part Five-Pricing and Underwriting Discretion!

This is the last in my series on the high points of Disparate Impact and Fair Lending; although there are a lot more tips and techniques on the way.  I can tell you that after attending this most recent conference, the regulators are expecting great things from us.  So now it is up to us to pay attention and demonstrate how we comply, or face the consequences.

The topic of discretion received the title of “Lending and Pricing Discretion, The Next Big Bombshell”.  This is an area of high focus in the exam process for mortgage lenders and coincidentally the largest attractor of DOJ filings.  The regulators made it clear that any discretion elevates your level of risk.  They also acknowledge that every business will have discretion, and that this discretion may be okay if done properly.  Here is what the experts recommend:

  1.  Heavily monitor ANY discretion in pricing or underwriting.
  2. If someone receives discretion then highly document why.  For instance, if the loan officer offered a pricing exception because of competition, you will need to produce that proof and also require a loan officer comment.
  3. You must monitor discretions and look for trends.  For instance, if you are consistently priced too high, then thought needs to be given to your pricing policy.  However, do not make the mistake of lowering prices in non-minority areas and keeping them the same in minority areas.  The argument that one borrower shops harder than another will not be tolerated.
  4. If you issue underwriting exceptions, then what are those trends?  Perhaps you need to adjust your underwriting criteria if you find yourself giving exceptions regularly.  When defining your credit standards, it is very important to define them to the greatest detail.  Here is an example.  Your DTI may not exceed 38% on product xyz, unless one of the following criteria is met; 6 months reserves, a credit score in excess of 700, the new house payment will not exceed the old house payment.  This way, when you need to explain why one client qualified at 40% DTI and another didn’t, you have guidelines that were applied consistently regardless of protected class status.
  5. Any discretion should require a notation from the loan officer or underwriter.  No exceptions.
  6. All denials should go through a second review process.
  7. Set firm parameters for discretion in pricing.  For instance, a loan officer may not vary more than 25 basis points in price without the express written authorization of a manager.  If this policy is applied consistently, documentation is gathered when outside of this, notations are required when this discretion is exercised and you monitor the application of these discretions for protected and non-protected classes, then you are demonstrating a strong compliance management system regarding exceptions.  The examiners also recommend that you adopt a “second sign off” to minimize your discretion risk.  Generally, this is handled by a member of management.
  8. Check your “additional” underwriting documentation requirements.  If you are going “outside the box” for documents beyond your written underwriting guidelines, this is considered discretion because it falls outside of policy.  Therefore, if it is not applied consistently to all applicants you may have an issue.
  9. Train beyond the basics in fair lending.  Every person comes with pre-conceived opinions and judgments about types of people and areas of properties.  The stronger your policy and the more highly defined your guidelines, the less likely these “feelings” will creep into the pricing and approval process.
  10. Pay attention to your customer complaints!  They may identify a trend you are not aware of.

I know that many of you are shell-shocked right now, and to be honest so am I.  This is a whole new world for us, as we have always been independent types.  My goal is not to be the grim reaper of news, but instead to give you a heads up, from those examined before you!

Tammy Butler, Master CMB

Author Tammy Butler, Master CMB

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