JAN 31, 2014

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Compliance Matters

More Fair Lending Scrutiny on the Way

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Disparate impact alleged in Fair Housing Act complaints remains a high concern for mortgage originators as they enter the new era of the qualified mortgage.

Disparate impact occurs when a lender’s practices have a discriminatory effect on borrowers, despite no intent to discriminate. Regulators use statistics to prove such cases. Disparate impact is different than disparate treatment, which is an intentional pattern and practice of discrimination.

The Consumer Financial Protection Bureau’s ability-to-repay/QM rule took effect Jan. 10. It has lenders wondering whether the lending requirements under QM could result in disparate impact claims against them.

The U.S. Supreme Court was poised to rule on disparate impact claims under the Fair Housing Act in 2012. However, the case in question was withdrawn. Another Supreme Court case presented disparate impact legal challenges in 2013, but that case settled, again denying the Supreme Court an opportunity to be heard on the issue.

The lack of a Supreme Court ruling has left the mortgage industry still seeking a guidepost as to whether such claims are valid under the Fair Housing Act, which prohibits housing discrimination on the basis of race, color, religion, sex, familial status or national origin.

In November, 2013, the House Financial Services Subcommittee on Oversight and Investigations held a hearing titled "A General Overview of Disparate Impact Theory." Testimony was presented by three experts on the issue, but no formal action was taken.

The possibility certainly exists that mortgage applications rejected by lenders under the ability-to-repay/QM rule will be reviewed by regulators for potential disparate impact claims.

Both the Department of Housing and Urban Development and CFPB have said in past memorandums that they intend to apply disparate impact theory when reviewing compliance with the Fair Housing Act or the Equal Credit Opportunity Act.

Last year, HUD issued a final rule titled “Implementation of the Fair Housing Act’s Discriminatory Effects Standard,” which makes any housing practice with a “discriminatory effect” on a protected class a violation of the FHA even in the absence of any intention to discriminate. And in 2012, the CFPB issued a bulletin stating the agency “reaffirms that the legal doctrine of disparate impact remains applicable as the bureau exercises its supervision and enforcement authority to enforce compliance with the ECOA and [its implementing regulations].”

While the CFPB doesn’t have jurisdiction under the FHA, who is to say the regulator wouldn’t use its broad authority in the mortgage market to inform the DOJ in Justice’s fair housing investigations? This is in the realm of possibilities, suggests Heather Klein, an attorney at Ballard Spahr LLP, in a recent legal commentary.

In 2012, U.S. Supreme Court was scheduled to hear oral arguments on Magner v. Gallagher, but both parties agreed to withdraw the case. Industry experts at the time contended the withdrawal was a quid pro quo between the DOJ and the city of St. Paul. St. Paul agreed to withdraw the case on the DOJ’s behest in exchange for the Fed’s agreement to drop an unrelated case against the city. Legal analysts at the time were speculating that the high court would strike down the use of disparate impact under the FHA. If that had happened, it would have curbed future DOJ and CFPB disparate impact investigations, including the CFPB’s use of the doctrine in the auto lending industry.

In the St. Paul case, a group of rental property owners sued the city and several officials over aggressive code enforcement that resulted in the closure of some properties. They claimed St. Paul violated the Fair Housing Act through its get-tough enforcement, which reduced availability of affordable housing for the city’s lower-income and minority residents.

The second case, Township of Mount Holly v. Mt. Holly Gardens Citizens in Action Inc., settled before going before the court.

In that case, residents of a low-income neighborhood of Mount Holly, N.J., said the town’s plan to demolish low-income housing as part of a revitalization effort discriminated against the town’s poor, minority residents.

Klein, the attorney at Ballard Spahr, wrote in a recent legal commentary that recent fair lending cases brought by the DOJ “reflect a trend of using disparate impact-type evidence to support disparate treatment claims. The DOJ often pleads facts that, arguably, support both theories of discrimination,” she said.

Disparate impact alleged in Fair Housing Act complaints remains a dubious and still-untested theory at the highest level of our nation’s court system, but it’s one that could be used as a hammer against mortgage originators.

There is concern among mortgage industry experts that the government intends to continue to use the disparate impact theory by building cases based on disparate impact analysis. Accordingly, mortgage originators must become educated on the doctrine and be vigilant in every aspect of compliance with the Fair Housing Act and the new ability-to-repay/QM rule.

Alex Kangelaris is CEO and managing partner at Wall Street Emprises LLC. He has over 25 years of mortgage industry and capital markets experience.

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