Are you worried about fair lending violations? You're not alone. It's a critical issue of the highest priority for compliance officers in every major financial organization in the US.
Discriminatory policies, procedures, and practices, even unwitting ones, constitute a violation of fair lending regulations that may result in fines and penalties, litigation, and reputational harm to the lender.
As any compliance officer knows, complying with the rules and regulations that govern the finance industry is not optional, and keeping up with the ever-changing laws and regulations can be overwhelming if your firm doesn’t have the right tools in place.
So what can you do to help your organization avoid costly infractions?
All financial institutions need a robust compliance program. If yours doesn't have one already, urge your leadership to institute a fair lending compliance program to identify, manage, monitor, and report risks. Or maybe you have one, but leadership says it's too expensive. Its effectiveness is questionable, and you're overwhelmed trying to stay ahead of the next potential disaster.
If you know your company is at risk due to an inadequate or ineffectual approach to managing fair lending compliance, we can help. You need a comprehensive, efficient, and sustainable solution to help you proactively address non-compliance issues. We can help you gain insight into your organization's compliance risk and monitor it, reduce non-compliance incidents, help you train, execute testing, and strengthen your compliance management program.
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The courts have recognized three types of lending discrimination under fair lending laws. In this article, we take a look at the laws, three types of lending discrimination identified by the courts and show you a few real-world examples to give you a good idea of what to look for. You can help your institution avoid making these mistakes by finding weaknesses in the processes that may allow discriminatory mistakes.
3 Fair Lending Violation Examples
Federally regulated fair lending is a closely-coordinated combination of requirements and prohibitions in several consumer protection and civil rights laws and regulations. These laws ensure financial institutions provide fair and equitable treatment and offer uniform services to all customers and when making credit-related decisions.
Fair Lending Laws consist of the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA). Fair lending laws protect consumers from unfair lending practices that could keep them from getting a loan based on their race, sex, or other discriminatory factors.
The Equal Credit Opportunity Act (ECOA) applies to discrimination in credit transactions, the extension of credit, and includes residential real estate lending and extensions of credit to small businesses, partnerships, corporations, and trusts.
The Fair Housing Act (FHA) guidelines cover residential real estate transactions such as mortgage loans, equity loans, construction loans, or the availability thereof, selling, brokering, or appraising real estate, advertising, or renting a dwelling.
ECOA protects loan applicants and borrowers from discrimination based on color, race, religion, sex, national origin, age, or marital status. It prohibits discrimination if an applicant's income comes from a public assistance program or whether the applicant has exercised any right, in good faith, under the Consumer Credit Protection Act.
FHA, implemented through HUD regulations, prohibits discrimination based on color, race, religion, or sex, national origin, familial status (parents with children under the age of 18, pregnant women, or persons with legal custody of children under 18) and handicap. It also requires lenders to make reasonable accommodations for a person with disabilities, when necessary, to give the person an equal opportunity to apply for credit.
As both the ECOA and the FHA apply to mortgage lending, lenders may not discriminate in lending based on the prohibited factors listed in either of them.
Additionally, a lender may not:
- Fail to provide or provide inconsistent information or services related to lending, including credit availability, application procedures, and lending standards.
- Discourage or selectively encourage credit applicants, refuse, or use dissimilar criteria when making credit decisions.
- Change the terms of credit offered, including the amount, interest rate, duration, and type of loan, or use different standards to evaluate collateral.
- Treat a borrower differently when invoking default remedies or servicing a loan.
- Use different standards when pooling or packaging a loan in the secondary market.
- Express orally, or in writing, a preference or indicate that it treats applicants differently.
- Discriminate because of the characteristics of an applicant, prospective applicant, borrower, or someone associated with them.
- Discriminate because of the characteristics of the present or prospective occupants of the property to be financed.
- Discriminate because of the characteristics of the property's neighborhood or area.
So, what have the courts recognized as discrimination, and what potential consequences do lending institutions face if deemed in violation of the fair lending regulations? There are a multitude of government agencies that regulate and oversee financial institutions and markets. They examine banks for evidence of discrimination and take remedial or punitive action if they find any. They will also investigate and can take action in response to consumer complaints.
Agency enforcement actions are costly to the institutions involved, and often also to individuals at those institutions. The affected entities have to spend money and resources correcting the identified problems and possibly pay restitution to the aggrieved parties on top of steep fines. There is the reputational cost too, which varies by the type and severity of enforcement action.
Liability under the fair lending statutes for discrimination is civil, not criminal. However, there is criminal liability under the FHA for interference with efforts to enforce the FHA, such as withholding or altering evidence or forcefully intimidating persons seeking to exercise their rights under the FHA.
A person alleging injury may sue the lender in federal district court. If the individual wins, they can recover the actual damages, reasonable lawyers’ fees, and court costs. If the court finds that the lender's conduct was willful, it will award punitive damages and other equitable relief. The act sets no maximum for these damage awards.
And individuals don't have to stand alone against lending institutions. If there are multiple people with the same claim, they may collectively file a class-action suit. Private fair housing and civil rights agencies actively facilitate fair lending actions taken by individuals and have produced a number of victories for borrowers either in court, in settlements outside court, or through complaints made to federal enforcement agencies.
Cities can also sue lending institutions over FHA violations if they target minorities for risky, costly mortgages, and the city suffered harm by these actions.
The Justice Department may also pursue a civil action against a suspected violator. Such action may occur if they receive a consumer complaint, a case referral from another enforcement agency, or if the Justice Department suspects a pattern of violations. The courts have recognized there are three methods of proof for lending discrimination under the FHA and the ECOA:
- Overt evidence of disparate treatment
- Comparative evidence of disparate treatment
- Evidence of disparate impact
Overt discrimination is obvious and usually intentional. This generally occurs when a lender treats members of a group under a protected class differently than others and when a lender expresses a discriminatory preference.
Disparate treatment may or may not be intentional. A lender may not be motivated by prejudice or the conscious intention to discriminate. It occurs when a lender treats credit applicants differently based on a prohibited factor.
Disparate impact generally happens unintentionally. This generally occurs when a lender's otherwise neutral policy, applied equally to all individuals, has a disproportionately adverse impact on a particular protected class.
You can typically establish the existence of illegal disparate treatment in a couple of ways. Either by statements that reveal a bank explicitly considered prohibited factors (overt evidence) or with the differences in treatment themselves, not fully explained by legitimate, non-discriminatory factors (comparative evidence).
1. Overt Discrimination
Overt discrimination happens when a lender openly or actively discriminates against someone based on a prohibited factor. If a lender conspicuously offers more favorable terms to individuals in one group than another based solely on one of the prohibited factors, such as gender, that would be overt. An example would be if a lender refuses to do business loans for women because, in the lender's opinion, women can’t run a business.
Overt evidence typically occurs through a blatant statement of discrimination that may be verbal or reflected in written advertisements.
Overt discrimination also exists when a lender expresses but does not act on a discriminatory preference. An example would be when a lending officer says, "We prefer not to carry mortgage loans for Native Americans, but according to the law, we are not allowed to discriminate, and we have to comply with the law."
Overt discrimination isn't necessarily deliberate. For instance, a loan product with an age requirement inconsistent with established legal requirements would be considered discriminatory based on age.
One example of overt discrimination is when Bellco Credit Union denied home loans to women on maternity leave. The lawsuit, filed by a community organization, the Denver Metro Fair Housing Center (DMFHC), against Bellco Credit Union, alleged discrimination against potential borrowers on the basis of sex or familial status.
Between May and August 2016, DMFHC tested Bellco's policy by calling to apply for mortgage loans. The five testers called the credit union, posing as similarly situated women with a credit score in the mid-700s, a two-earner household income, and savings that ranged from adequate to substantial. Three of the women claimed to be on or about to start maternity leave. The DMFHC reported that loan representatives told all three women they wouldn't do the loan until they returned to work and could provide one month’s worth of pay stubs.
When one tester reminded the loan officer that she was on paid maternity leave, the loan officer went so far as to say: "Bellco still would not consider her earnings until she had returned to work for a month because '[a] lot of people say they are going back to work and then they don’t so that is why we require that you actually are back at work in order to use your income.'"
To assume a woman will not return to work after childbirth is a Fair Lending violation. The lender is prohibited from requiring any qualified applicant who is pregnant or on maternity leave to return to work and earn a specified number of paychecks before approving or closing her loan.
According to HUD, “Borrowers scheduled to be on leave at the time the first mortgage payment is due may rely upon any combination of income received during leave or liquid assets not otherwise required for the loan to meet the underwriting standards.”
The suit asked the judge to enjoin, or block, Bellco from continuing its practices, to award punitive damages, compensatory damages, attorneys’ fees, and other reasonable costs. Bellco ended up settling the lawsuit by agreeing to pay $57,250 to EEOC.
Disparate treatment is a difference or inconsistency in customer treatment based on prohibited factors that cannot fully be explained by relevant, non-discriminatory factors and can range from overt discrimination to subtle disparities in treatment. Comparative evidence of disparate treatment, typically discovered through a comparative analysis during a fair lending examination, is the less favorable treatment of a protected class applicant than other applicants’ treatment.
Of the three types of discrimination, this is the most common type found within banking institutions and the most likely to be targeted in a fair lending review.
It's not required to show that the difference in the lender’s treatment of the applicant was motivated by prejudice. If a lender apparently treated similar applicants differently, it must provide an explanation for the difference in treatment.
The lender can successfully rebut the presumption of discrimination by presenting a legitimate reason for the actions. If the lender cannot offer a credible explanation, the agency or court will likely infer that the lender discriminated. The courts consider the difference in treatment to be illegal discrimination if no legitimate non-discriminatory business need can justify the difference in treatment.
The U.S. Justice Department filed an official complaint in the Manhattan federal court against JPMorgan Chase for fair lending violation. The complaint stated that JPMorgan Chase showed "reckless disregard" for 53k+ minority borrowers' rights.
The complaint claimed the alleged discrimination involved wholesale loans made through mortgage brokers that JPMorgan used to originate the loans. Chase allowed the brokers to change rates charged for loans from those initially set based on objective credit-related factors.
As a result, minorities were charged more for home loans than white borrowers with the same credit profile and ended up paying tens of millions of dollars in additional mortgage costs.
As a result, the company settled the lawsuit for a price tag of $55 million.
3. Disparate Impact
Disparate impact happens when a lender applies neutral practices or policies without intentional discrimination equally to all credit applicants, but the practices or policies disproportionately burden or exclude people in a protected group when there is no legitimate, non-discriminatory business need for the policy.
A practice or policy that creates a disparity on a prohibited basis is not by itself proof of a violation. When an examiner finds that a lender’s practice or policy has a disparate impact, the agency must determine whether the policy or practice has a ‘‘business necessity" justification.
The justification must be unambiguous and may not be speculative or hypothetical. Relevant business necessity justifications for a policy or practice include cost or profitability. Where the practice or policy is justified by "business necessity," and there are no less discriminatory alternative policies or practices, there will be no violation.
In 2012, SunTrust Mortgage settled a lawsuit with the Department of Justice, wherein SunTrust was accused of charging higher interest rates and fees to minority borrowers. The investigation into SunTrust Mortgage’s lending practices was initiated by a referral by the Federal Reserve.
It reviewed over 850,000 residential mortgage loans originated by SunTrust between 2005 and 2009 to monitor the bank’s compliance with the FHA and the ECOA and found that SunTrust set prices based on objective credit-related criteria but allowed its own loan officers as well as its national network of brokers to adjust those prices without regard to borrower risk.
By allowing these price adjustments, Latino and African-American customers paid more than Caucasian borrowers. SunTrust inadvertently "incentivized discrimination" by sharing the inflated charges with those loan officers and brokers. Because the discrimination was unintentional on the bank’s part, this was considered a classic case of disparate impact, which resulted in a $21 million price tag to settle.
Fair lending violations can be elusive. It is important to understand these three types of discrimination and how they can occur to fully evaluate fair lending risk.
Even well-intended lending practices or policies can become problematic if your organization doesn't implement regular monitoring and training. Regulatory changes and enforcement practices, most of which have been consumer-centric, are increasing. Intensified scrutiny of fair lending laws has been a regulatory enforcement priority. Regulatory agencies have shown no sign of decreasing their examinations of fair lending practices. As they continue, they will hold lenders accountable for fair lending violations with enforcement actions.
To effectuate fair lending practices and avoid the increasing mountain of potential enforcement settlements and fines, you need to take a proactive role to ensure your organization is in compliance with regulatory expectations.
Bringing in a compliance and risk management service provider — like us — gives you peace of mind knowing that a regulatory expert has your back. With our guidance, you’ll know for sure that your bank complies with all the regulatory requirements.
Take our quiz to determine how mature your current compliance and risk management program is, and contact us when you’re ready for us to perform a risk assessment and get help.