A new survey of mortgage industry practices examines the prevalence of pricing discretion in lenders' operations. Careful management of the practice is crucial to avoiding fair lending problems.
As advisers to mortgage lenders on operations, risk management and compliance, our clients often ask us about best practices in managing the fair lending risk attached to pricing discretion. Pricing discretion goes by many names in the mortgage industry: overages and underages, premiums and shortages, secondary gain, concessions or exceptions. [paragraph] Whatever the label, lenders ask us how much discretion other lenders give to loan officers versus others in the organization, what are allowed justifications for pricing adjustments, how the justifications should be documented and how fair lending risk should be monitored. [paragraph] In this article, we use the results of a benchmarking survey we performed to answer some of these questions and to compare industry practices against what we understand to be regulatory expectations for fair lending risk management.
What we learned
From a fair lending perspective, we believe lenders should think broadly about pricing discretion as including any judgmental adjustments to standard pricing, as listed on rate sheets or given by a pricing engine. We advise lenders to consider all categories of pricing discretion whether that takes the form of discretionary reductions or increases in interest rate or points; lender credits or fees; or rate-lock extensions, roll-downs or similar adjustments.
Our survey confirms that discretionary pricing remains an important part of doing business in the mortgage industry. Many lenders appear to find it necessary for competing effectively, accommodating customer preferences and needs, and providing good customer service.
We also found that pricing discretion is commonly exercised to help comply with certain regulatory requirements or regulation-driven business policies.
Even though the typical reasons for discretionary pricing adjustments appear to be grounded in legitimate business needs, whenever someone is empowered to vary some element of the price of credit to consumers on a judgmental, case-by-case basis, that raises a risk that borrowers with comparable qualifications and credit risk will receive different pricing outcomes.
If pricing differences tend to occur based on race, ethnicity, gender or another prohibited basis, regulatory enforcement agencies may conclude that illegal discrimination has occurred under the Fair Housing Act and Equal Credit Opportunity Act (ECOA). The Supreme Court is considering the question of whether disparate impact liability exists under the Fair Housing Act in the case of Texas Department of Housing and Community Affairs et al., us. The Inclusive Communities Project Inc. Even if the court decides that disparate impact liability is not available under the Fair Housing Act, pricing discretion may still pose a fair lending disparate treatment risk under both the Fair Housing Act and the ECOA, and the Consumer Financial Protection Bureau (CFPB) has made clear its position that disparate impact is actionable under the ECOA.
For this reason, the pervasiveness of discretion needs to be matched with adequate controls to avoid potential fair lending issues or enhanced regulatory scrutiny.
Our survey covered some of the key compliance program elements cited in the CFPB's spring 2014 Supervisory Highlights report: policies and procedures, documentation, record retention, monitoring and senior management oversight.
The survey findings suggest the following observations regarding industry compliance programs.
Policies and procedures: Formal, written policies and procedures governing the exercise of discretion are typical, but are not nearly universal, and often don't cover all aspects of pricing discretion. In particular, only about half of respondents covered discretionary lender credits in their written policies.
Clear policies and procedures are fundamental to establishing controls around discretion, and the fair lending risk created by discretionary lender credits is conceptually no different from that created by discretionary pricing concessions.