Lending fees represent a major area of risk among forms of fair lending discrimination. In this article, we explore a fair lending analysis of fees.
In this series of posts, we address types of fair lending discrimination that are commonly recognized by the regulatory and enforcement agencies. The points covered are risk areas that are often examined in the course of regulatory reviews. It is critical to bear in mind that fair lending laws and regulations are vast and, accordingly, there is almost an infinite number of pressure points. Our goal in this series is simply to draw from our experiences in our fair lending practice and provide information that will assist in reducing risk.
Broadly speaking, there are two categories of fair lending reviews that can be conducted: (1) underwriting and (2) terms and conditions. These are the reviews that have traditionally formed the core of both bank monitoring as well as regulatory reviews. There are obviously lots of areas of fair lending risk – most we will cover in future articles. In terms of side-by-side type file reviews or using statistical analysis, these are the traditional types of fair lending inquiries.
Underwriting is simply the loan decision – were loan applications approved or denied? Terms and conditions apply to approved loans and cover the other aspects of the credit transaction including pricing and other product requirements or features.
A pricing analysis is the most common type of terms and conditions review. Pricing can be measured by a number of ways, one of which is fees. Most loans have some type of fee associated with the loan which can include origination fees, documentation preparation fee, credit report fees, and so forth. Most fees in some way relate to the loan amount, term, interest rate charged or, in the case of commercial credit, the complexity of the transaction.
Fair lending risk is greatest to the extent (a) fees are discretionary and/or can be waived and (b) fees schedules vary. For example, the risk would be significant if individual loan officers could waive fees and there was no clear guidance or policy governing the charging of fees. Equally, the risk would be very high where fees could be reduced or increased, again with no clear guidance, policy or enforcement of said policy.
Fair lending risk exists whenever there is discretion, and it is amplified when there is some type of incentive to exercise this discretion. Incentives in regard to fees can take a number of forms, and it is important this be avoided.
Fair Lending Analysis of Fees
Fees can be evaluated (2) ways: the incidence of actual fee charges such as the frequency, if when fees are charged or changed and also the size of the fee. Fees can also be evaluated by analysis of the APR as well as independently as described.
Examiners, therefore, could analyze how often a fee is charged to one group or another. They may also consider the magnitude of the fee, such as the average for one group versus another. If an institution has variation in fees within products, these would be important measures to know.
The actual pricing of loans in regard to the interest rates and APR’s charged should be one of the easiest areas of fair lending risk for a financial institution to manage. Having a poorly defined fee structure that varies within products or the inconsistent application of loan fees adds an unnecessary layer of fair lending risk and one that can prove very difficult to manage. Where loan pricing in terms of the interest rate is easily tracked and managed, having variation in fees can prove to be problematic.
Avoiding fair lending pricing risk with regard to fees can be done very easily as follows:
- Have a clear fee structure
- Fees should be consistent within products
- Trust but verify – know what is being done in practice in your institution
- If there is variation in fees this must become part of your analysis and tracking
- Incentives should not be tied to fees directly or indirectly
- Fees should make sense and be appropriate with respect to the type and size of the loan
- Don’t deviate with regard to fee charges – it’s not worth the risk