The mortgage banking industry initially let out a collective gasp of horror when, last month, the U.S. Supreme Court upheld a circuit court's ruling that the legal doctrine of disparate impact applies to the Fair Housing Act.
However, as two mortgage professionals recently told MortgageOrb, the decision is actually a win for mortgage lenders, as it provides greater clarity with regard to the circumstances under which borrowers might bring class-action lawsuits.
The 5-4 decision means borrowers who feel they were discriminated against when their loans were denied can bring class-action lawsuits against lenders – regardless of whether a lender's policies are found to be intentionally discriminatory.
In writing the court's decision, however, Justice Anthony Kennedy says that although minorities who allege racial discrimination don't have to prove intent to sue, mere statistical evidence of a policy's impact on a minority group might not, in and of itself, be grounds for a suit.
Kennedy further warns that when courts rule in disparate impact cases, they cannot impose racial targets or quotas, as that could be unconstitutional.
Importantly, Kennedy clarifies that in order for a party to bring a disparate impact claim under the Fair Housing Act, it must establish ‘robust causation’ by providing statistical or other evidence that a lender's internal policies directly caused a disparate impact.
In other words, as long as a lender is making a ‘good faith effort’ to target underserved borrowers in a particular area, a court will likely not consider any claim based on disparate impact against that lender.
Put another way, it must be statistically proven that the lender's policies had the effect of discrimination in order to bring a class-action lawsuit under the Fair Housing Act.
Brian Koss, executive vice president for Mortgage Network, says when the decision was first announced, some people thought it would ‘create an atmosphere of fear’ and that lenders might dial back credit as a result.
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But the decision is actually a good thing for the mortgage industry, Koss says, ‘because the interpretation of disparate impact previously was so wide open and so vague, it made it too easy to bring a suit.’ He says although the decision ‘didn't give [the mortgage industry] the clarity we would like – in that there was no real finding – at least this gives us some blocks [to work with].’
‘For one thing, the interpretation is cleaner in that [a borrower] really has to show intent – there has to be proof of negligence,’ he says.
Koss adds that in some respects, the SCOTUS decision creates a situation that, from a lender's perspective, is ‘similar to the TRID grace period [recently discussed by the Consumer Financial Protection Bureau] in that this is all about intent.’
‘If you're able to show that you're making a good faith effort to comply [with the Fair Housing Act] – that you're trying to monitor and you're trying to do the right thing, [you will be recognized for it],’ he says. ‘Whereas before, the way this rule was written, [a disparity] could totally be unintentional, but [regulators] could still say, 'You should have known.' If they really wanted to nail you, they could.’
Because the recent ruling brings greater clarity regarding the circumstances under which class actions would be heard, Koss says he doesn't think this will ‘have any impact on any lender that has already been living with this since 1993,’ referring to a suit (HUD Secretary v. Mountain Side Mobile Estates) that was adjudicated administratively by the U.S. Department of Housing and Urban Development (HUD) and that ultimately led to disparate impact's being more universally applied to the Fair Housing Act.
‘I don't think it's a bad thing, unless there's another case that gives rise to another bad definition,’ he says.
Rick Roque, managing director of retail for non-depository mortgage lender Michigan Mutual, agrees that the ruling provides greater clarity for bringing class-action lawsuits, which is a good thing for lenders. At the same time, he says, lenders could be doing a lot more to target creditworthy black, Latino and Hispanic borrowers and bolster their diversity numbers. In fact, the ruling should help motivate lenders to get a slice of the underserved market, which, by his estimate, is an approximately ‘$400 billion opportunity.’
‘This is an interesting ruling … because it addresses, in many cases, the unlawful practices in zoning laws and other housing restrictions that function to directly or indirectly exclude minorities from specific neighborhoods without sufficient justification,’ Roque says. He adds that the effect of the ruling is that lenders will likely start loosening their internal overlays in an effort to go after more ‘thin file’ minority borrowers who are currently sitting on the sidelines due to stricter lending standards.
Part of the problem is that ‘fair lending scares the daylights out of non-depositories,’ Roque says, adding that non-depositories are far less likely to originate riskier loans and, out of a culture of fear, have recently looked to the depositories, who are already held to certain requirements for diversity under the Community Reinvestment Act (CRA), to fill that role.
‘Depositories are already held to a CRA requirement, around the U.S., by their examiners, who might say, 'You are not doing enough to lend to minorities or underserved demographics; therefore, we are going to pull your license or we are going to put you on probation, which could potentially prohibit your ability to lend in the areas of the state you want to lend in,'’ Roque explains.
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Although Massachusetts and New York are among the states so far to hold non-depositories to diversity standards, and other states are following suit, it's been happening ‘too slowly,’ Roque says. This recent ruling will likely have the effect of forcing more non-depositories to pay attention to their Fair Housing statistics and to strive for greater diversity in originations.
Roque says, in his opinion, that going after the underserved market isn't as risky as most lenders think, as there are many minority borrowers out there today who are creditworthy – they simply lack the required employment and income documentation to qualify. Many minorities, he says, pay their rent and bills on time – they have sufficient income – it's just that it cannot be documented in a way that meets the regulations and, in particular, lenders' internal policies.
‘The housing crisis really suppressed black and Latino homeownership,’ he says. ‘Consider that about 15 percent of the U.S. is Latino, and yet only about six to seven percent of all mortgage applications that close go to Latinos. Blacks represent about 11 to 12 percent of the U.S. population and yet represent only about four percent of all closings.’
‘A healthy market should have black mortgage close rates at between eight percent and nine percent,’ Roque says. ‘In a normalized market, Latinos would make up about 10 to 11 percent. If you do the numbers, the Latino, black and Hispanic markets combined is about a $400 billion opportunity for the mortgage industry. The problem is non-depositories don't know how to market to these audiences, and as a result, they paint with a broad brush by saying, 'These groups don't pay their bills; therefore, they're not the ones we want to go after.' And, as a result, rulings like this recent one scare them to death. What they don't understand is that disparate impact, as it applies to the Fair Housing Act, is entirely consistent with the purpose of the Federal Housing Administration.’
However, the fundamental question remains: Should lenders lend based on race or should they lend based on economic circumstances only?
‘You have to remember that more than 50 percent of borrowers who got subprime loans pre-crisis would have qualified for a prime loan – that's a Fannie Mae statistic,’ Roque says. ‘So, if you look at the approximately $1 trillion worth of subprime loans done between 2004 and 2007, more than 50 percent of that could have been done in a prime environment. We already know roughly two-thirds of those were sold to minority borrowers. But the problem was that lenders weren't specifically looking for the creditworthy Latinos or blacks.’
Roque says there remains ‘a significant opportunity in targeting the underserved.’ It's simply a question of identifying the creditworthy minority borrowers who have been shut out of the market due to their inability to fit the credit box as defined by the current regulations and lenders' internal underwriting standards.
‘The problem is not the Fannie and Freddie and [Federal Housing Administration] guidelines. The problem is that lenders put so many overlays on the guidelines,’ Roque says. ‘When we hire an underwriter, most often we don't train him to the guidelines – we train him to the conditions – and he ends up adding 20 to 30 conditions. Then it ends up becoming a documentation nightmare.’
Roque says it is the ‘thin file’ borrowers, ‘the ones with three or four part-time jobs and undocumented income – the ones who have moved multiple times yet have adequate income and have been paying their rent – those are the borrowers that are automatically disqualified.’
‘There's a lot of nitty-gritty in the underwriting process that can easily change, in terms of what underwriters are looking for – but they don't, because there is a lot of pressure on the operations side and the compliance side,’ Roque says. ‘You have a chief financial officer and you have a compliance officer who tend to scare the daylights out of people with the fear of the unknown.
‘Find some way to redline the circumstance and suddenly you have a creditworthy borrower,’ he adds.
One of the biggest challenges facing lenders, however, is that in order to target the underserved and pick up more minority market share, they are going to have to hire more minorities.
‘In many respects, who you hire dictates who you are going to sell to,’ Roque says, adding that the Dodd-Frank Act encourages enforcement of multi-cultural hiring in the mortgage industry. ‘If you don't have Hispanic people working for you, you will not lend to Hispanic borrowers; it's pretty much that simple,’ he says.
The other challenge is that when it comes to targeting the underserved, ‘most lenders don't know how to price the loans on the street,’ he says.
‘Is it sensible to have some variance between loan officers?’ Roque asks rhetorically. ‘In other words, should pricing be based on where the loans are being offered? Regulators are going to have to provide guidance on this.’
Bottom line: Because of the wording of the recent SCOTUS decision, lenders now have a greater degree of protection from class-action lawsuits claiming disparate impact in that racial imbalance, in an of itself, does not establish a case of discrimination. What's more, the ruling means lower courts will be required to more closely scrutinize the claims being presented – which, in turn, should help protect lenders against ‘abusive’ claims.