Underwriting Overlays
The next step in evaluating your Fair Lending risk is to take a hard and in-depth look at your underwriting guidelines. This is truly a deep dive into your product lines, and why you require certain overlays that may have Disparate Impact in areas within your MSA.
Example of this are:
- Minimum loan amounts that exclude an area.
- Credit score overlays that do not match up with credit scores in a protected class area, but are accepted by the investor, and where other lenders are able to do profitable business.
- Restrictions on types of income, length of income, disability or maternity income.
- Restrictions on assets and how they are verified.
- Anything that is over and above what the investor requires as a minimum.
As an Executive team there are multiple concerns, if your overlays do not serve the population base of “Qualified Borrowers” in your MSA:
- First you need strong market knowledge of your MSA.
- If you simply offer the underwriting guidelines of the investor, what can truly be sold to the markets, and what does that loan look like. Do you have written evidence or examples of loans with no overlays that were not picked up by the investor, despite what they say in their guidelines? What caused you to require the overlay? If you are going to defend it, you have to clearly document the reasons.
- Is that overlay reasonable and supports a documented business justification?
- Have you reviewed your overlays and questioned why you need them both economically, and looking at how they may cause Disparate Impact?
- How do you compare to your peers? (similar size and make-up)
- How will changing your overlays affect your compare ratios with FHA? How will keeping them affect Fair Lending?
There is certainly no easy answer to any of these questions and much of it has to do with careful, documented rationale. As you ponder this, ask:
- What level of risk are you willing to take?
- How much can you truly afford for any penalties resulting from Disparate Impact? (Hint it is generally in the millions when they find an issue).
- Is the risk/reward for the overlay worth it? This means comparing a potential financial risk with the potential financial revenue and the reputation risk associated with that.
- Take a look at what others offer in your MSA. Is there a profitable alternative to what you offer that can even out your lending, and offer access to credit for all qualified clients in your MSA?
No one is suggesting that you lend to unqualified borrowers or take financial risk beyond what you deem appropriate. Quite the contrary, the regulators and civil rights litigators, are adamant that you offer equal access to credit to the population base of your MSA for “Qualified Borrowers”. They are not advocating (and I hope they never do) providing financing for clients who are not financially ready to buy. There is a big difference between the two.
When the CFPB does send you notice of an exam, they will be quite impressed with the leg work you have done in thoughtfully looking at how you can serve all of the qualified clients in your MSA.
Finally, I’d like to remove your fears about underserved, low to moderate income areas. When you align yourself with non-profit housing counseling agencies, I think you might be surprised by the quality of client they produce. Unlike many clients who cross your threshold, these clients have been educated in financial management, savings and budgeting. The counselor typically will not encourage them to buy until they are financially sound and ready. Sometimes, the loan amounts are lower, the time to close is longer and the types of underwriting situations you will experience are different, however, it is a great source of business and a fantastic way to safely reach out to the underserved markets.
