Magazine article Mortgage Banking

Disparate Impact: A Conundrum Wrapped in Enigma and Paradox

Magazine article Mortgage Banking

Disparate Impact: A Conundrum Wrapped in Enigma and Paradox

Article excerpt

"[T]here is no point in driving yourself mad trying to stop yourself going mad. You might just as well give in and save your sanity for later." --Douglas Adams, Life, the Universe and Everything

The Fair Housing Act and Equal Credit Opportunity Act ban intentional discrimination on the basis of race, color, religion, national origin, gender, familial or marital status, age, handicap or the applicant's receipt of income from public-assistance programs. The residential lending industry is well aware of these guidelines and the case law that has developed to further define the parameters of acceptable and unacceptable behavior.

What it is not familiar with, and what's giving mortgage bankers heartburn, are the recent decisions by the Department of Housing and Urban Development (HUD) and the Consumer Financial Protection Bureau (CFPB) to apply the "disparate impact" or "disparate effect" theory when assessing lender and servicer compliance with fair lending laws.

Under the disparate impact rules recently promulgated by HUD and the CFPB, lenders are prohibited from engaging in lending policies and decisions that, while neutral on their face, have a disproportionate and adverse impact on anyone protected by the fair lending laws. While preventing discrimination in mortgage lending is certainly a laudable goal, the Qualified Mortgage/ability-to-repay (QM/ATR) rules require that lenders consider a borrower's income and credit history, among other items, when determining whether that borrower has a reasonable ability to repay the mortgage according to its terms.

And therein lays the conundrum, paradox and enigma: Minority groups and single-female heads of household generally have lower incomes and lower credit scores. This limits their ability to obtain a loan and makes the loans they do get more expensive due to the increased risk of default.

These borrowers may also have difficulty in getting their loans modified or in repaying according to the modified terms. Thus credit and risk-based QM/ATR lending and loan-modification decisions are likely--statistically speaking--to violate the disparate impact rule.

HUD declined to give any assurance that adhering to QM/ATR standards--or any other standards, for that matter--will protect against fair lending claims based on disparate impact. When the question is presented at conferences, HUD and CFPB representatives usually remind lenders that they can always make non-QM loans. What they don't usually say is that the ATR rules apply to non-QM loans, and non-QM loans are likely to be more expensive in part because of the higher risk of litigation and liability involving foreclosures.

The non-QM loans originated today are generally to wealthier borrowers. But what if a secondary market develops and non-QM lending starts to look--statistically speaking--like the old subprime lending that is associated in the public's mind with targeted and predatory lending in minority communities?

While "business necessity" and the lack of a reasonable alternative to achieving legitimate business considerations are defenses against fair lending claims, Home Mortgage Disclosure Act (HMDA) data is readily available on the Web and all an aggrieved person has to do to get in the door of the courthouse is to show that a disparity exists. As Mark Twain observed, facts are facts but statistics are pliable. With such a low threshold for forcing a lender or servicer into court, the disparate impact rule puts a big target on the industry's forehead, and we should think about boosting our legal defense budgets now--and by a lot. …

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