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. Today’s entry will cover the unfair practice known as “steering.”
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.
Steering is simply a loan applicant being guided into a particular loan product that may have less favorable terms or conditions than an alternative product. The terms and conditions could encompass a large number of product features including the actual interest rate or rate type, fees, or conditions of the loan such as the requirement for or types of insurance.
Although the terms and conditions of similar products may vary, the current regulatory position does not necessarily require that harm be demonstrated to establish the presence of steering.
The risk of steering exists to the extent an institution has products that overlap. i.e., one or more products may suit a customer’s needs. As an example, agencies have been concerned for some time about steering of loan applicants between lending channels, such as bank in-house lending as opposed to secondary market lending.
Depending on the rate environment, borrowers have been able to obtain lower interest rates on longer term mortgages from secondary market products. The rates have sometimes been lower than banks can fund internally, and this combined with the longer term of the credits results in lower APR’s. Thus, assuming that more favorable terms are available through the secondary market, agencies often pay close attention to distribution of loans by race, ethnicity, and gender between these two areas.
Steering risk however exists for any number of products which are similar but the terms and/or conditions are different. For example, if a customer is seeking a home improvement loan, a term loan or a home equity line of credit may suit their needs. These loans likely have different rates as well as terms, so this could present steering risk.
In addition, an unsecured loan may also suffice in some instances. This means there are 3 possible products that may fit the customer’s circumstance in this scenario. A similar situation can exist with regard to seasonal and special marketing promotions – does the customer receive the “normal” product or are they instead directed to the promo?
Another example could be a loan applicant seeking a small unsecured loan such as $5,000 to cover some expenses. Options may be a small short term loan, a credit card, or a line of credit attached to a checking account. These all likely have different rates, terms and conditions and present potential risk in regard to steering.
Steering risk is greatest when an institution has overlapping products and the requirements to obtain each are also similar. This creates a situation where a customer may qualify for a number of products that are priced differently which, in turn, elevates risk.
Here are a few keys that will help reduce steering risk:
- Evaluate your product mix and eliminate overlap where practical
- Ensure lenders understand products the bank offers and how the terms and requirements differ
- As possible, if terms and conditions differ, the requirements for each product should also differ
- Have a process to ensure that applicants are aware of and understand all the products and services the bank offers
- Document the above process in each loan file as well as customer choices
- Data should be analyzed on a regular basis to determine the distributions by race, gender, and ethnicity of critical products
As a final point, bear in mind that regulators may “shop” an institution to test steering or other aspects of fair treatment of applicants. It’s, therefore, important to understand what is happening on a day-to-day basis in regard to service delivery as it relates to lending practices.