Loan Pricing and Compliance Considerations

If there’s one issue that can slip you up, it’s loan pricing discretion unmanaged, which naturally increases fair lending risk. In 2011, the Truth in Lending Act was amended with the MLO compensation rule, which prohibits financial institutions from providing financial incentives to an MLO based on the terms and conditions of a loan.

In July 2018, the Federal Reserve issued a new publication, Consumer Compliance Supervision Bulletin. In this publication, the issue of mortgage target pricing was briefly discussed. While the publication acknowledges that the MLO compensation rule has reduced fair lending risk, it has done so only at the mortgage loan originator level, and that risk still exists for mortgage pricing.

According to the publication, some financial institutions “that originate mortgage loans for the secondary market now set a “target price” for each mortgage loan originator. This means that the bank sets a specific profit margin target for the mortgage loan originator. This target price can be achieved with any combination of a higher interest rate and/or discretionary fees charged to the borrower. These target prices are based solely on discretion and not on the risk-related credit characteristics of the borrower. This arrangement may comply with Regulation Z as long as the bank does not vary the loan originator’s compensation based on different prices for borrowers. That is, the bank still complies with Regulation Z if it sets one compensation arrangement with one target price for each loan originator.”

Where the fair lending risk increases is when a financial institution’s MLOs have different target prices and the MLOs that have higher target prices serve minority areas. The publication mentions two such cases which were referred to the Department of Justice; one resulted in an enforcement action.

So, even though your financial institution may have a loan pricing policy, now might be a good time to review fair lending risks. The publication provides key steps in managing risk:

Check for compliance with Regulation Z with respect to financial incentives

Implement policies and procedures to control the risk that discretion could lead to a fair lending violation

Evaluate and managing the risk when the mortgage loan originators with the higher target prices tend to serve minority neighborhoods

Monitor pricing by race/ethnicity across mortgage loan originators, including the APR, interest rate, fees, and overages, using statistical analysis if there is sufficient volume

Consider mapping loans by target price

In addition, keep in mind that prudential regulators also provide clues as to how they will assess and measure fair lending and its risks. For instance, the FDIC in its Compliance Manual, covers pricing. Here are some of the questions asked:

Does the bank have a written loan policy that addresses pricing?

Does a review of the bank’s policies raise any overt or other potential fair lending concerns with respect to pricing?

Does the bank provide loan officers with a rate sheet, matrix, or written guidance for pricing loans?

Does the bank allow discretion in the setting of loan terms and conditions (including interest rates or fees) for residential real estate lending?

Does the bank track and monitor loan and pricing exceptions?

Are loan officers compensated based on pricing of loans?

Are controls in place to ensure consistency in pricing practices?

Do credit pricing systems or processes vary by product or lending channel?

Does the bank’s pricing vary by region, office, or branch?

Has the pricing process for any loan product changed since the previous compliance examination?

Or, if the FDIC is not your prudential regulator, do you know where to look online for examination procedures or guidance regarding pricing discretion? Take the time to review your financial institution’s policies and procedures, monitoring, documentation, range of discretion, and board of director/senior management oversight.

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