How Much Discretion is Allowed?
By: Greggory B. Oberg, Esq.
Pricing Discretion in Lending: How Much is “Too Much”?
Fair lending remains one of the tougher compliance obligations to adhere to in practice today, despite the intents of related laws being clear and uncontroversial. As more data becomes available through sources like HMDA and certain private databases, fair lending has increasingly become a numbers game for many institutions. It’s not enough to simply have policy that shows your commitment to fair lending, you must have numbers that back it up.
Over the course of hundreds or thousands of mortgage files originated throughout a year (or possibly even a longer assessment period), variance is going to occur even within in one institution or one single loan officer. It must, right? Lenders aren’t machines, and despite the proliferation of automation in the lending space, nothing in the law has ever (or probably will ever) tells us that every loan must be identical. Pricing will necessarily vary, and we cannot always account for why. This is discretion, and is the focus of intense scrutiny in internal and external review of fair lending data.
If we accept that some discretion is permissive and normal, any fair lending analysis will ultimately get to the same question: how much?
The simple answer, at least today, is “less than our peers.” But this isn’t completely helpful, and I’ve been searching for more. Consider the following CFPB action, and to what extent lessons may be extended to the mortgage lending industry.
Toyota Motor Credit
Without getting too deep into the facts, there are a LOT of similarities to the mortgage origination process. Here’s how it goes:
- A borrower would apply for credit with the local dealership
- The dealership submits a credit application to Toyota’s credit arm for underwriting
- Toyota Motor Credit approves or denies, and sets a “buy rate” which can be very easily thought of as a “rate lock” in our industry
Once that “buy rate” is set, the dealer is free to mark it up, sometimes adding up to 250 bps during the period investigated by CPFB. The dealer then consummates the transaction, and (in most cases) Toyota Motor Credit will acquire the debt.
When the CFPB found that this structure resulted in disparate treatment, they gave Toyota some options for improving the process moving forward.
From the Consent Order:
Respondent will limit Dealer Discretion in setting the contract rate to one hundred and twenty-five (125) basis points for retail installment contracts with terms of sixty (6o) months or less, and one hundred (100) basis points for retail installment contracts with terms greater than sixty (6o) months.
Additionally, Toyota was required to implement monitoring programs and internal controls to ensure that the discretion permitted under the consent order is not applied in a discriminatory manner.
Lessons?
While there is nothing iron clad, I feel Toyota stands for the proposition that discretion is permitted in lending, and that it’s probably a bigger tolerance than you think it is. How much more? That’s a question for another day.
Read the Consent Order and Summaries Here: