Are banks unfairly denying certain loan applicants?
A national consumer coalition plans to file a series of landmark federal fair housing complaints beginning Dec. 6, challenging a widespread practice by banks and mortgage lenders: requiring borrowers who apply for FHA loans to have FICO credit scores well above the 580 minimum set by the FHA for qualified applicants with 3.5 percent down payments.
The complaints allege that the higher FICO requirements disproportionately discriminate against African American and Latino borrowers, many of whom have credit scores above the 580 threshold set by FHA but below the 620 to 660 minimums frequently imposed by private lenders. FICO scores run from 300 to 850, with higher scores correlated with lower future risk of default.
Because FHA insures lenders against losses from serious delinquency or foreclosure, there is "no legitimate business justification" for rejecting applicants solely on the basis of FICO scores that are acceptable to FHA, the complaints contend.
The identities of the 20-plus mortgage lenders who are expected to be the subjects of fair lending filings were not available in advance. But John Taylor, chief executive of the National Community Reinvestment Coalition, which plans to file the complaints, said they include "large, medium and small banks," all of whom maintain minimum FICO scores higher than what FHA requires. The coalition represents 600 local and regional consumer, economic development and civil rights groups and has long been an advocate of equal opportunity in mortgage lending.
According to a draft complaint that I obtained in advance, the coalition conducted what it calls "extensive" blind tests among lenders active in the FHA program. Testers presented themselves to loan officers as financially qualified applicants for FHA-insured mortgages, with FICO scores between 601 and 605. Loan officers routinely informed them that they cannot accept applicants with FICOs less than 620.
When applicants responded that they knew FHA is willing to insure loans for borrowers with credit scores as low as 580, often they were told the same: We require higher FICO scores on FHA loans than the FHA does.
Lenders with higher FICO policies "knew or should have known that African-Americans and Latinos disproportionately have credit scores between 620 and 580, both within the FHA portfolio" and within the lender's market areas. As a result, the complaint argues, these lenders' policies have "the effect of discriminating against African-Americans (and) Latinos."
In an interview, Taylor said "the insidious part of these policies" is "not simply that they discourage" minorities from purchasing homes, but they also are "cutting off refinancings" that might be available via FHA for current homeowners who need loan modifications to avoid foreclosures.
The FHA, which was created by the federal government during the Great Depression, traditionally has been a crucial source of mortgage financing for moderate-income, minority and first-time home purchasers.
Asked what he thinks about lenders' independent credit score cutoff limits, David H. Stevens, the FHA commissioner, said the current FICO 580 minimum standard is "based on pretty in-depth analysis of performance data" by borrowers, and represents an acceptable level of risk for the agency consistent with its mission.
In an interview that did not touch on the upcoming fair-lending complaints, Stevens said he has "concerns" about the negative impacts lenders trigger when they impose stricter credit-score standards on applicants than the minimum required by FHA. This is especially the case when borrowers' scores are low not because they are "habitual late payers," but because they've experienced unforeseen economic reverses such as recession-related job losses or uninsured medical bills.
One of the country's top advisers to FHA lenders, Brian Chappelle, a principal with D.C.-based Potomac Partners, said banks set higher credit-score limits for sound economic reasons: They are concerned about costly indemnification demands from the FHA and "reputational risk" in the investment community if low-FICO loans go sour. Also, Chappelle said, they don't want to lose valuable revenue they receive for servicing FHA-insured mortgages that are paying on time.
Terry H. Francisco, a spokesman for Bank of America, one of the highest-volume FHA lenders, confirmed that rationale and said the bank sets its own "credit standards based on our best analysis of an applicant's capacity and willingness to repay the loan."
Brian D. Montgomery, the immediate past FHA commissioner, agreed that the recent "stricter credit" limits have "some [people] asking if FHA is still serving [its] traditional type of borrower." But, he said, the potentially heavy "incremental expenses of managing delinquent borrowers" are the key drivers of rising credit score standards.