Will the “Ability to Repay” Rules Create a Fair Lending Risk?  

Of the many regulations that will be implemented in 2014, one of the most talked about is the “ability to repay”   rule.  This rule requires banks to make a good faith effort to determine a borrower’s ability to repay a loan before the credit is extended. The rule specifies the type of documentation that is required to meet the standards set.  The rule also establishes a “safe harbor” that allows banks to be presumed to make loans that meet the standards of the regulation as long as the bank makes “qualifying loans”.  Essentially qualified mortgages are loans that are not deemed higher priced.[1] 

Generally, the decision has been made by banks that the best way to avoid the ability to repay rules is to simply make only qualifying mortgages.  For many banks, making the decision to originate only qualified mortgages also means reducing the type of products being offered and potentially the volume of consumer mortgages.  Some of our clients have asked then, whether or not the decision to offer only qualified mortgages will create a Fair Lending concern. 

The good news is that the regulatory agencies that comprised the FFIEC have issued a statement on this very topic.  [2]  At first glance it appears that the statement clearly tells banks that issuing only qualified mortgages should not be a Fair Lending concern. 

“…the Agencies do not anticipate that a creditor’s decision to offer only Qualified Mortgages would, absent other factors, elevate a supervised institution’s fair lending risk” [3]

However, we advise that the emphasis has to be placed on the words absent other factors.  And in fact, the statement goes on to describe what some of the other factors might be.   The statement makes clear that banks and financial institutions are always required to follow safe and sound practices when making loans.  And in point of fact, despite wide spread belief to the contrary, there is nothing in consumer regular that requires banks to make lower quality loans.   For example, the preamble to the Community Reinvestment Act specifically reminds banks that all loans should be made with safety and soundness as basic considerations.     

However, Fair Lending and its   regulations are a different “brand of cat” from other consumer regulations.   When reviewing a Bank’s compliance in the area of Fair Lending, regulators will consider not just compliance with the letter of the law, but also the impact that policies and practices have on members of the bank’s assessment area.   Therefore, the decision to make a certain type of loan or to cease offering a product can be totally in compliance with the requirements all consumer regulations.  However, the impact could be disproportionate to members of the banks customer base.  For example, suppose a bank decides to stop offering second mortgages, of longer than 5 years in length.   This decision is neutral on its face as it appears to impact all potential borrowers at the bank in the same manner.  However, if a study is completed that finds that this decision resulted in a reduction of all applicants that are in protected classes, there could be a Fair Lending concern.  The impact of the decision had a disparate impact on the borrowers from protect classes that reside in the bank’s assessment area. 

It is important to note that a practice can have a disparate impact and still not be a Fair Lending concern.  If the practice meets a legitimate business need that cannot reasonable be achieved in a manner that has less disparate impact, then the Fair Lending test is met.  [4]  The point here is that there must be some research done and documentation that there is a specific business purpose for the practice.  The decision discussed above can have the disparate impact that we described, but if the bank that made the decision can also show that there for example a direct relationship between the loan terms and its funding sources, there is likely a strong business reason for the decision. 

The interagency statement makes it clear that the same standard will be used to determine whether a bank’s decision to offer only qualified mortgages is a matter for Fair Lending concern.  As the statement notes, there are several ways that a financial institution can qualify for the safe harbor status including selling mortgages to federal agencies such as Fannie Mae and Freddie Mac.  Therefore, a decision to cease certain products without considering how they may still be qualified mortgages may not be received favorably by the regulators.   

In our opinions banks should not simply and arbitrarily decide to make only qualified mortgages in an attempt to meet the ability to repay rules.  A more thorough consideration is required.  Thought must be given to how this decision fits in with the strategic plan of the bank as well as the impact on the surrounding community.   Complete documentation of the business reasons why the decision is being made is critical to defending against claims of disparate impact or unfair practices.  

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[1] Higher-priced loans are generally defined as having an annual percentage rate (APR) that, as of the date the interest rate is set, exceeds the Average Prime Offer Rate (APOR) by 1.5 percentage points or more for first-lien loans and 3.5 percentage points or more for subordinate-lien loans

[2] CA 13-15 Interagency Statement on Fair Lending Compliance and the Ability-to-Repay and Qualified Mortgage Standards Rule

[3] Ibid

[4] Ibid