Friday, May 28, 2010

Why Suitabilty Tests and Fiduciary Duty May be Incompatible with ECOA

Starting out in the mortgage industry in 1998, I planned to make mortgage lending my career, so I was eager to learn as much as I could about my new profession. As part of my training, I took a lot of classes, and some of those classes involved training by the National Association of Mortgage Brokers on Fair Housing Laws and Equal Opportunity Credit Act laws. I was really surprised to learn that the standards for complying with these laws were quite a bit higher than I had understood.

For example, I thought that complying with the law meant treating everyone with respect, and working to get their loans processed, but I found out that according to the Equal Credit Opportunity Laws treating everybody fairly involved more than that. A broker offering a product had to make it available equally to everyone who qualified for it. A loan officer was not supposed to make credit decisions for a borrower. A loan officer was not supposed to refuse to take an application on any borrower or to process any borrower's application. We were told that we needed to at least send the application to a lender so that the lender could decline the loan regardless of how credit unworthy we believed the application to be. To refuse to do so could be construed as discriminating against the borrower. The loan originator had no right to decide whether the borrower could or should have a loan; that was the job of the credit underwriter.

Opponents of the industry have long held that certain products are unsuitable for certain types of people. For instance, one group of consumer advocates floated the idea that people over a certain age should not be allowed to apply for mortgage loans because they could be victims of predatory lending. Our Association responded that Equal Credit Opportunity Laws prohibited discrimination based on age and provided senior citizens with the same rights as people in other age groups to make their own decisions.

Today, as part of the new financial reform bill, we are seeing new standards for loan originators which have grown out of recommendations by consumer advocacy groups. These specifically include suitability tests for matching loan products to clients and fiduciary responsibility for loan originators to their clients.

The problem with this kind of a standard is that it creates a framework in which individuals can and must discriminate against borrowers. For example, under a suitability test, if a 75 year old wants to take out a thirty year equity loan against their home, should the loan originator refuse to process the loan because it is unsuitable for a person of that age? Last year, I received a phone call from a woman who was very frustrated because she had been trying to get a loan on her home at a major national bank. She had almost paid off a home equity loan on her home, and she wanted another one. Under Texas law she complied with the requirements for a home equity loan. She and her husband had retirement income of over $13,000 a month for life, and they had excellent credit. But the bank wanted to give them a reverse mortgage, which they did not want. And the bank had also asked her why she wanted the money, and when she told them that she wanted to redo her kitchen and give some money to her children, they told her that her children were taking advantage of her and she should not be giving them money.

Now, to the bank, a reverse mortgage seemed to be the most suitable product, since she was in her late sixties and her husband was in his early seventies, but as far as this borrower was concerned, their refusal to listen to her and respond to what she wanted was discriminatory. "I know my rights," she fumed as she recalled her experiences. "The bank cannot make me tell them why I want the money." I assured her that she would not have her privacy invaded. We processed the application, and she closed within 20 days.

But with a suitability standard, who decides whether a product is suitable for the borrower? Does the originator decide and refuse to process the application? Does the underwriter decide and decline the loan because it is not suitable for the borrower? Is there another final person who reviews it to decide whether the borrower has received the right product?

These are serious questions that could ultimately lead to serious law suits and legal problems as borrowers, originators and underwriters fight over who knows best about a person's financial planning and needs. And since suitability is really subjective, one company may feel, as in this case, that the older borrower belongs in a reverse mortgage while another company may feel that they belong in a home equity loan. Does a judge ultimately decide who is right?

What about the person who wants to be on a three year arm because they want a lower interest rate while their kids are in school, but the loan originator knows that a fixed rate is safer. Who is right? Who is going to make the decisions for which the borrower is literally going to be paying every month?

Sen Judd Gregg (R-NH) says in an article published May 24, 2010, "You'll basically have a consumer protection agency which decides to go out in the morning and say 'well everybody who's XYZ should have a loan, even though the local community bank says XYZ shouldn't have a loan, because if we give them a loan, we know they're not going to pay it back.' It's going to become an agency that defines lending on social justice purposes instead of safety and soundness purposes."

There is probably some truth to Gregg's statement, but I think that what we are going to see is a lot of willy-nilly decision making by a lot of different players rather than one set of guidelines equally applied to everyone. And when that happens, both equal credit and equal opportunity go out the window.

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