Are Your Underwriting Policies Creating Fair Lending Risk?
The recent Fifth Third Mortgage and Freedom Mortgage settlements provide key insights about underwriting policies, complaint management, third-party risk and the treatment of disability income. Your current policies may be putting your firm at risk. Read on to learn more…
The U.S. Department of Justice (DOJ) filed a settlement earlier this month with Fifth Third Mortgage Company "to resolve allegations that it engaged in a pattern or practice of discrimination on the basis of disability and recipient of public assistance in violation of the Fair Housing Act (FHA) and the Equal Credit Opportunity Act (ECOA)," according to the press release. The lawsuit arose due to a complaint submitted to the U.S. Department of Housing and Urban Development (HUD), which referred the case to the DOJ.
Fifth Third allegedly discriminated against loan applicants on the basis of disability and receipt of disability income. This was done by allegedly requiring, as a condition of originating a mortgage loan, that some applicants provide a letter from a doctor showing that Social Security Disability Income and other disability income would continue. It is important to note that Fifth Third denies the allegation of discrimination.
Both the bank and the mortgage broker named as the second defendant, Cranbrook Mortgage Corporation, agreed to revise policies regarding disability income and provide training to employees about the updated policies. Fifth Third will also pay $1.5 million to compensate victims, and the mortgage broker will pay $2,000 to compensate those loan applicants who filed the complaint, according to the press release. Going forward, neither Fifth Third nor the mortgage broker will request that a mortgage loan applicant provide a letter from a doctor to document or substantiate Social Security Disability Income (SSDI) or other disability income in order to establish disability income will continue, according to the consent order. This settlement provides key insights regarding underwriting policies, complaint management, and third-party risk.
It is logical to assume that banks are looking to accommodate both regulatory and investor requirements regarding the documentation of an applicant’s income or anticipated income. The CFPB tells financial institutions that “your organization must verify the information you rely on using reasonably reliable third-party records.” However, policies for disability income should not rely upon documentation from doctors or medical records in establishing Ability-to-Repay (ATR). According to the Federal Reserve, “this prohibition includes letters from doctors that address: duration of a disability; nature of a disability; or severity of a disability.” Existing regulations, including ECOA and FHA, and recent settlements provide guidance about establishing compliant disability income and ATR policies.
ECOA: ECOA prohibits discrimination in any aspect of a credit transaction, including the applicant’s receipt of income derived from any public assistance program.
FHA: FHA prohibits discrimination in all aspects of residential real estate related transaction. The FHA prohibits discrimination on the basis of making housing unaffordable; making discriminatory statements; and/or offering discriminatory terms or conditions. The FHA also prohibits lenders from requesting unnecessary and unduly burdensome disability income documentation.
Bank of America settlement, 2012: This recent Fifth Third settlement has some similarities to a 2012 Bank of America settlement that also dealt with policies for documenting disability income.
“Loan applicants with disabilities should not be subjected to invasive requests for medical information from a doctor when they are applying for credit,” said Thomas E. Perez, who was the Assistant Attorney General at the time.
Bank of America also denied the discrimination allegations in agreeing to the settlement. Bank of America revised its policies regarding documentation of disability income when underwriting mortgage loans, and they no longer request “that an applicant for a mortgage loan provide a letter from a doctor to document or substantiate income or to establish the duration of disability income.”
So what is a "reasonably reliable third-party record"? The CFPB suggests the following broad categories in their Ability-to-Repay and Qualified Mortgage Rule Guide:
- Records from government organizations such as a tax authority or local government
- Federal, state, or local government agency letters detailing the consumer’s income, benefits, or entitlements
- Copies of the consumer’s federal or state tax returns
- Check-cashing receipts
Freedom Mortgage settlement, 2014: For additional insight into the "right way" to manage disability income, we can look to the August 2014 settlement between Freedom Mortgage and HUD. Within this settlement, Freedom Mortgage’s new credit policy was reviewed and approved by HUD. This "policy complies with the requirements of the Fair Housing Act,” according to HUD. Below is an excerpt from the approved Freedom Mortgage policy:
“If, in the loan application or origination process, a Freedom Mortgage loan originator or processor has a question regarding continuity of disability benefit income, the employee must consult with a Freedom Mortgage underwriter for appropriate guidance and resolution before making any statement to the loan applicant.
In any event, no such loan applicant shall be required to provide documentation regarding continuity of income beyond the proof of continuity of income required under the relevant underwriting or investor guidelines.
We may verify income by obtaining any of the following documents from the borrower:
- Federal tax returns, validated with tax transcripts
- Recent bank statements evidencing receipt of income from the identified source
- A Proof of Income Letter (Budget Letter or Benefits Letter) from the identified source
- Copy of borrower's Form l099 or 1042S from the identified source
Certain types of income related to a disability do not have defined expiration dates for example, Social Security Disability Insurance benefits, Supplemental Security Income, or Veterans Disability Compensation benefits. When income related to a disability falls within a category that does not have a defined expiration date, the income is considered stable and reasonably expected to continue for the next three years.
For the purposes of establishing continuity of income, Freedom Mortgage employees shall not request that a loan applicant provide a doctor's letter, medical diagnosis, or other form of medical information, nor shall they make inquiry regarding the nature or severity of a loan applicant's disability.”
This Freedom Mortgage policy, in its entirety, can be found in the conciliation agreement found in the "Read More" section below. Additionally, Social Security provides instant access to benefit verification letters through a “my Social Security” account; see the "Read More" section below for more details.
In addition to policy, the Fifth Third settlement reminds us that complaints can be a primary trigger for regulatory attention. We heard on a recent regulatory conference call that “all it takes is one complaint.” Financial institutions must actively track, review, manage, and respond to consumer complaints. In the case of Fifth Third, the loan applicants submitted complaints to HUD, which referred the case to the DOJ.
It is interesting to note that the 2012 Bank of America consent order mentioned above also established a complaint resolution program “to address complaints alleging discrimination on the basis of disability and/or the receipt of public assistance with regard to requests for a doctor’s letter concerning verification of disability income.”
We've written previously about the value of a strong consumer complaint management system (CMS). In that post, we explain why it's essential that you review your institution's CMS, and how the right CMS can help support outstanding customer service and provide new insights to management.
Finally, the Fifth Third settlement highlights the fact that third-parties play play a significant role in the credit transaction, and may bring additional Fair Lending risk to the credit transaction. This was true with Fifth Third’s relationship with the mortgage broker (second defendant in the case).
The FDIC stated that “examiners should evaluate all applicable activities conducted through third-party relationships as though the activities were performed by the institution itself.” Without identifying third-party risks, an institution cannot measure or manage them effectively. Some questions to consider: do your outside brokers understand your policies and procedures? Are you conducting third-party annual due diligence?
Ncontracts Viewpoint: In the future, success for financial institutions will require careful navigation between ATR, ECOA/FHA, and investor guidelines. In particular, disability income is an area that must be considered in policy and trained upon. The regulators have been clear: financial institutions should not request doctors to document or substantiate or establish the duration of disability income. There are other ways to verify disability income. For example, Social Security income can be verified by the Social Security Administration or Federal tax returns.
At the same time, government agencies and investors can be very specific about their individual requirements. The HUD handbook states that “Social Security income should be verified by the Social Security Administration (SSA) or from Federal tax returns.” The HUD-approved policy language above may help your institution chart the appropriate course.
At Ncontracts, we study these settlements to gain valuable insights on behalf of our clients. We actively apply these implied lessons in our day-to-day regulatory consulting.
- Fifth Third DOJ Settlement from August 2014
- Freedom Mortgage HUD Settlement from August, 2014
- Bank of America Consent Order Regarding Disability Income
- FDIC Third Party Risk
- Ability-to-Repay and Qualified Mortgage Rule – Small Entity Compliance Guide
- HUD – Borrower Employment and Employment Related Income (HUD – 4155.1 – Chapter 4, Section D.)
- Social Security – Fastest Way to Verify Social Security And Supplemental Security Income Benefits
- Mortgage Credit Analysis for Mortgage Insurance (HUD – 4155.1):