CFPB Eliminates Disparate Impact

YOUR QUESTION 

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You may have heard about a major change to Regulation B. They eliminated disparate impact. I also learned that they changed a few other areas that were working to reduce discrimination. As an underwriter, I think this is wrong-headed. I think this reduces fair lending protection. 

We met with our lawyer because we have a second review process, which weeds out potential discrimination in our loan process. Our lawyer says there is a shift away from not having to prove intent to discriminate to now having to prove intent. She says that this is a problem because proving intent is extremely difficult. In other words, discrimination is now possible without having to prove intent to discriminate – only the outcome matters. 

So, if I get this right, even if the outcome is discrimination, the company that discriminated won't be held responsible if you can't prove an intent to discriminate. I don't understand why disparate impact protection is being weakened. It’s scary! 

Do the changes to Regulation B basically eliminate disparate impact? 

OUR COMPLIANCE SOLUTION 

Policies and Procedures 

OUR RESPONSE 

I am going to be blunt: the CFPB's April 2026 Final Rule ("Rule") amending Regulation B eliminates the "effects test" – that is, "disparate impact" – of the Equal Credit Opportunity Act (ECOA), while also restricting special-purpose credit programs (SPCPs), and narrowing the definition of "discouragement" of applicants or prospective applicants. This is clearly a significant regulatory shift away from fair lending restrictions. 

However, saying it eliminates disparate impact and fair lending is not accurate. The Rule eliminates disparate impact liability specifically under ECOA and Regulation B. That's significant, but ECOA is only one of several legal frameworks that govern lending discrimination. The Rule does not affect several others that remain fully intact. 

The Fair Housing Act (FHA) still recognizes disparate impact for mortgage lending. The Supreme Court confirmed this in Texas Department of Housing v. Inclusive Communities Project (2015), and the Rule expressly does not touch FHA liability. So a mortgage lender whose policies produce racially skewed outcomes can still face a disparate impact challenge under the FHA, which is a completely separate statute.

State fair lending laws are arguably the bigger remaining protection. Many states – for instance, California, New York, Illinois, and others – have their own anti-discrimination statutes that incorporate disparate impact standards, and federal rulemaking cannot preempt those. State attorneys general were among the most vocal opponents of the Rule precisely because they intend to continue using their own authorities. 

The Department of Justice retains independent enforcement tools. And the Community Reinvestment Act, which addresses lending patterns in lower-income communities, operates on its own separate framework. 

HOW DID THIS HAPPEN? 

The CFPB received over 64,500 public comments, including ours. The overwhelming majority of comments opposed the Rule. Nevertheless, the Rule is now law. The compliance effective date is July 21, 2026. Whatever the comments offered, pro or con, the Rule largely finalizes a November 2025 proposal, with only clarifying edits rather than substantive revisions. 

Since your question specifically involves the change to disparate impact, I will discuss it primarily. The other changes are also very significant and should be incorporated into your policies and procedures. 

Eliminating the “effects test,” a change supposedly meant to lower compliance costs, actually gives lenders greater freedom to target protected groups. 

WHAT IS THE EFFECTS TEST? 

The purpose of the “effects test” is ultimately to protect against disparate impact. The "effects test" is actually a legal doctrine used to determine if a lender’s facially neutral policy creates a discriminatory, disproportionate impact on a protected class (for instance, race, gender, or age). It means a creditor can be liable for discrimination, even without discriminatory intent, if their practices have a discriminatory effect. 

Most regulators know full well that they can challenge lending policies that, while appearing neutral, create a negative impact on protected groups. Most compliance lawyers know full well that a financial institution can expose itself to a disparate impact violation by creating a pattern or practice that results from defective lending policies. And most financial institutions know, or should know, that if a policy has a discriminatory effect, they must prove that a legitimate business necessity justifies it. 

What the CFPB has done is to remove the “effects test” from Regulation B, thereby promulgating that ECOA does not recognize disparate impact liability. The focus now is on the intent to discriminate.

Sexual Orientation: Protected Class

QUESTION 

A banking department has cited us for a violation of the Equal Credit Opportunity Act, Regulation B. The allegation is that we denied several loans on the basis of sexual orientation. The applicants filed a complaint with the department. I will state the basis of the complaints. Based on their investigation, they issued an administrative demand to review our loan originations for the last three years. 

Other banking departments seem to be interested in this matter and have sent us document requests for loan files and loan logs. When I joined the company as its General Counsel two years ago, I undertook a review of administrative actions going back several years. Nothing like this happened. For the years I reviewed, we did not have complaints caused by violations of Regulation B, particularly, adverse action. 

In drafting our response to the department, I relied on case law, best practices, and specific regulatory guidelines. To ensure I have a deeper understanding of our legal exposure, I want your input on potential procedures that may cause a violation of the ECOA based on sexual orientation. 

What are potential procedures that may cause a violation of the ECOA based on sexual orientation? 

SOLUTION 

ECOA Tune-up 

Fair Lending Tune-up 

RESPONSE 

The Equal Credit Opportunity Act (ECOA), as implemented by Regulation B, prohibits discrimination on a prohibited basis in any aspect of a credit transaction. Prohibited bases under the ECOA are: race, color, religion, national origin, sex, marital status, or age (provided that the applicant has the capacity to enter into a binding contract); the applicant's income being derived from public assistance; or the applicant's exercise in good faith of any right under the Consumer Credit Protection Act or any state law upon which an exemption has been granted by the Consumer Financial Protection Bureau (CFPB). 

For any rejected application, you should provide a written notice that clearly explains the specific principal reason(s) for the decision. The notice must also include the ECOA disclosure and the name of the appropriate federal enforcement agency. 

The prohibited basis doctrine, as applied to sex, includes sexual orientation and gender identity. The Supreme Court ruled, in 2020, in Bostock v. Clayton County that the federal law prohibiting discrimination in employment based on a person's sex includes gender identity and sexual orientation. 

Following this decision, certain federal agencies with regulatory authority for sex discrimination were directed to review their agency procedures and determine whether actions should be taken to align them with the Bostock decision. Subsequently, the CFPB issued an interpretive rule clarifying that the ECOA and Regulation B apply to discrimination in credit transactions based on a person's sexual orientation and/or gender identity. The rule also provided guidance to clarify the requirements. 

The FHA prohibits discrimination based on race, color, religion, sex, familial status, national origin, or disability in the sale, rental, and financing of housing. In 2021, the Department of Housing and Urban Development confirmed that discrimination based on sexual orientation is a violation of the FHA. 

In light of this change, lenders sought to mitigate this risk by updating their policies and procedures to align with the change. For instance, many lenders now include a statement of nondiscrimination in their loan policy, loan advertisements, and applicant disclosures, and on their websites to reflect the ECOA's requirements. Lenders should update these documents to indicate they do not discriminate on the basis of sex, including sexual orientation or gender identity. We have continually urged our clients to conduct staff training on this issue. 

Because your question is very specific with respect to procedures, I am going to keep this article narrowly focused on methods and procedures to prevent violations of ECOA based on sexual orientation. There are surely three actions that must be done to avoid such violations. In my view, these would be 

(1) ensuring that policies and procedures are updated,

(2) training all affected personnel, and

(3) removing such discriminatory practices from credit decisions. 

I will treat them here, with the caveat that implementing these actions correctly and legally throughout the mortgage process requires a rather extensive implementation of various regulations, federal and state, a review that is far beyond the reach of this article.

Artificial Intelligence Disclosure

QUESTION 

I am the General Counsel and Compliance Officer of a mortgage lender. Our footprint is currently in 35 states. Recently, we have begun to use Artificial Intelligence in our loan origination process. However, I have some concerns about proper consumer disclosure. 

In my view, we should be disclosing our specific use of AI to borrowers. We should disclose the role AI plays in our loan applications from the point of sale to close, and, if applicable, beyond. But I do not find much regulatory guidance to lean on. I would appreciate your views on AI disclosure and, if possible, which areas would be subject to such disclosure. 

Is there a requirement for a mortgage lender to issue an AI consumer disclosure? 

What regulatory areas are potentially impacted by AI, thereby causing AI disclosure? 

COMPLIANCE SOLUTIONS 

AI Tune-up® 

Artificial Intelligence Statement  

RESPONSE 

There is currently no broad legal requirement for lenders to disclose the general use of AI in loan applications. However, under existing consumer protection and fair lending laws, lenders are legally required to disclose specific, accurate reasons for adverse actions, such as a loan denial, even if a complex AI or algorithmic system made the decision. 

This transparency is mandated by the Equal Credit Opportunity Act (ECOA), and regulatory bodies like the Consumer Financial Protection Bureau (CFPB) have issued guidance emphasizing that the complexity of AI is not an excuse for failing to provide a clear explanation. 

Regulatory Mandates 

Take, for instance, the regulatory mandates involving adverse action disclosure. The CFPB has directly addressed the issue of "black-box" models, which are AI systems whose logic is not clear even to their developers. The CFPB emphasizes that lenders cannot point to a broad category from a checklist, such as "purchasing history," if a consumer is denied credit based on AI analysis. Instead, the lender must provide specific details, such as the types of goods or places that influenced the decision. 

Also, there is no "AI exemption." A lender's use of AI or machine learning does not create a special exemption from fair lending laws. The CFPB has made it a priority to ensure that the use of technology does not allow lenders to circumvent established consumer protection regulations. In addition to the CFPB, regulators and the Federal Trade Commission have warned that there is no "AI exemption" for existing fair lending and consumer protection laws. Therefore, undisclosed AI could be found to violate these laws, leading to enforcement actions. 

The Colorado Artificial Intelligence Act 

Some state laws specifically address AI disclosure. For example, the Colorado Artificial Intelligence Act (CAIA) requires developers to test for algorithmic discrimination in consequential decisions, and some state consumer protection statutes allow for prosecution if an AI's biased outcomes cause consumer harm. This is a landmark act in many ways. If you are originating loans in Colorado, you should review the relevant regulations. However, you would do well to conduct a statewide review of AI legislation in all states where you are licensed to originate mortgage loans. 

CAIA may be a model for the direction states are going with respect to AI disclosure. The Act defines algorithmic discrimination, which is the unlawful differential treatment that disfavors an individual or group on the basis of protected characteristics. The algorithmic discrimination would be caused by high-risk artificial intelligence systems, defined as any system that, when deployed, makes — or is a substantial factor in making — a "consequential decision," which generally relates to those involving education, employment, financial services, housing, health care, or legal services. 

Under the CAIA, there are stipulated requirements for developers to clearly display on their website or in public use an up-to-date disclosure of any high-risk AI systems they have developed and make available how they manage known or reasonably foreseeable risks of algorithmic discrimination. Any determination that the AI system has caused or is reasonably likely to cause algorithmic discrimination must be brought to the attention of the Colorado attorney general, among others.

Artificial Intelligence: Adverse Action Notice

QUESTION 

We have used the model adverse action form for years. It is in our LOS. A question arose when our system put in a reason other than the model not accurately reflecting the basis for the adverse action. 

This happened because we are using artificial intelligence in our credit models. I head underwriting and credit operations and serve on the AI committee. Our decision to use AI did not contemplate that AI would produce an adverse action other than the model form’s requirements. 

Before making changes to our LOS or revising our policies, we want to find out if we must rely on the checklist of reasons for adverse action in Regulation B. 

Is it acceptable not to use an adverse action reason not available in the adverse action notice? 

How does artificial intelligence affect the accuracy required by Regulation B’s adverse action notice? 

ANSWER 

Creditors may not rely on the checklist of reasons provided in the sample forms (codified in Regulation B) to satisfy their obligations under the Equal Credit Opportunity Act (ECOA) if those reasons do not specifically and accurately indicate the principal reason(s) for the adverse action. Indeed, as a general matter, creditors should not rely on overly broad reasons to the extent that they obscure the specific and accurate reasons relied upon. 

The ECOA, implemented by Regulation B, makes it unlawful for any creditor to discriminate against any applicant with respect to any aspect of a credit transaction based on race, color, religion, national origin, sex (including sexual orientation and gender identity), marital status, age (provided the applicant has the capacity to contract) or because all or part of the applicant’s income derives from any public assistance program, or because the applicant has in good faith exercised any right under the Consumer Credit Protection Act.[i]  

When taking adverse action against an applicant, ECOA and Regulation B require that a creditor provide the applicant with a statement of reasons for the action.[ii] This statement of reasons must be “specific” and indicate the “principal reason(s) for the adverse action.”[iii] Furthermore, the specific reasons disclosed must “relate to and accurately describe the factors actually considered or scored by a creditor.”[iv]  

Adverse action notice requirements promote fairness and equal opportunity for consumers engaged in credit transactions by serving as a tool to prevent and identify discrimination by requiring creditors to explain their decisions affirmatively. 

Additionally, adverse action notices are supposed to provide consumers with an educational tool that allows them to understand the reasons for a creditor’s action and take steps to improve their credit status or rectify mistakes made by creditors. 

Indeed, the CFPB does provide sample forms that creditors may use to satisfy their adverse action notification requirements, if appropriate. And these forms include a “checklist” of sample reasons for adverse action, which “creditors most commonly consider.”[v] But, note, there are open-ended fields for creditors to provide other reasons not listed. 

Creditors use the sample forms to satisfy certain adverse action notice requirements under ECOA and the Fair Credit Reporting Act (FCRA),[vi] though the statutory obligations under each remain distinct.[vii] While the sample forms provide examples of commonly considered reasons for taking adverse action, “[t]he sample forms are illustrative and may not be appropriate for all creditors.”[viii]  

So, be aware, reliance on the checklist of reasons provided in the sample forms will satisfy a creditor’s adverse action notification requirements only if the reasons disclosed are specific and indicate the principal reason(s) for the adverse action taken. 

Now, concerning your question about artificial intelligence. 

Some creditors use complex algorithms involving “artificial intelligence” and other predictive decision-making technologies in their underwriting models. The CFPB has previously issued guidance affirming that creditors are not excused from their adverse action notice obligations under ECOA simply because they rely on complex algorithmic underwriting models in making credit decisions.[ix] 

These complex algorithms sometimes rely on data harvested from consumer surveillance or data not typically found in a consumer’s credit file or application. The CFPB has underscored the harm that can result from consumer surveillance and the risk these data may pose to consumers.[x] 

Some of these data may not intuitively relate to the likelihood that a consumer will repay a loan. Consequently, the Bureau and the prudential regulators have previously noted that these data may create additional consumer protection risks.[xi] For instance, adverse action notice requirements under ECOA and Regulation B ensure that financial institutions use the data and advanced technologies in a way that fully complies with other legal requirements, such as the prohibition against illegal discrimination.[xii] 

So, it is essential to understand that the CFPB, the Department of Justice, and other enforcement agencies have pledged to use their collective authorities to protect individual rights regardless of whether legal violations occur through traditional means or advanced technologies.[xiii] 

Under ECOA and Regulation B, a creditor must provide an applicant with a statement of specific reason(s) for an adverse action. These reasons must “relate to and accurately describe the factors actually considered or scored by a creditor.”[xiv] Thus, a creditor may not rely solely on the unmodified checklist of reasons in the sample forms provided by the CFPB if the reasons provided on the sample forms do not reflect the principal reason(s) for the adverse action. As explained in Regulation B,

 

“[i]f the reasons listed on the forms are not the factors actually used, a creditor will not satisfy the notice requirement by simply checking the closest identifiable factor listed.”[xv]  

Rather, the sample forms merely provide an illustrative and non-exclusive list.[xvi] If the principal reason(s) a creditor actually relies on is not accurately reflected in the checklist of reasons in the sample forms, it is the creditor’s responsibility – if it chooses to use the sample forms – either to modify the form or check “other” and include the appropriate explanation, thereby ensuring that the applicant against whom adverse action is taken receives a statement of reasons that is specific and indicates the principal reason(s) for the action taken. 

Let me be clear: creditors that simply select the closest, but nevertheless inaccurate, identifiable factors from the checklist of sample reasons are not complying with the law. Creditors may not evade this requirement, even if the factors considered or scored by the creditor may surprise consumers – as certainly can happen when a creditor relies on complex algorithms using data not typically found in a consumer’s credit file or credit application. 

Because it is unlawful for a creditor to fail to provide a statement of specific reasons for the action taken,[xvii] a creditor will not be complying with the law by disclosing reasons that are overly broad, vague, or otherwise fail to inform the applicant of the specific and principal reason(s) for an adverse action. Just as an accurate description of the factors actually considered or scored by a creditor is critical to ensuring compliant adverse action notifications, sufficient specificity is also required. Such specificity is necessary to ensure consumer understanding is not hindered by explanations that obfuscate the principal reason(s) for the adverse action taken. 

Specificity with respect to artificial intelligence is a critical regulatory concern. To be sure, specificity is particularly important when creditors utilize complex algorithms. Consumers may not anticipate that certain data gathered outside their application or credit file and fed into an algorithmic decision-making model may be a principal reason for reaching a credit decision, particularly if the data are not intuitively related to their finances or financial capacity. 

A creditor must “disclose the actual reasons for denial . . . even if the relationship of that factor to predicting creditworthiness may not be clear to the applicant.”[xviii] So, for instance, if a complex algorithm results in a denial of a credit application due to an applicant’s chosen profession, a statement that the applicant had “insufficient projected income” or “income insufficient for amount of credit requested” would likely fail to meet the creditor’s legal obligations. That would be the case even if the creditor believed that the reason for the adverse action was broadly related to future income or earning potential, providing such a reason likely would not satisfy its duty to provide the specific reason(s) for adverse action. 

I hope you are now getting a sense of how artificial intelligence impacts your credit decisioning and, by extension, the specificity required by the adverse action notice. Concerns regarding specificity may also arise when creditors take adverse action against consumers with existing credit lines. 

An example can be elucidated in an FTC complaint,[xix] where a creditor decides to lower the limit on, or close altogether, a consumer’s credit line based on behavioral data, such as the type of establishment at which a consumer shops or the type of goods purchased. In this instance, it would likely be insufficient for the creditor to simply state “purchasing history” or “disfavored business patronage” as the principal reason for the adverse action. Instead, the creditor would likely need to disclose more specific details about the consumer’s purchasing history or patronage that led to the reduction or closure, such as the type of establishment, the location of the business, the type of goods purchased, or other relevant considerations, as appropriate.[xx]

 The CFPB has determined[xxi] that the requirements under ECOA extend to adverse actions taken in connection with existing credit accounts (i.e., an account termination or an unfavorable change in the terms of an account that does not affect all or substantially all of a class of the creditor’s accounts), as well as new credit applications. However, such factors in a credit model may be improper for other reasons, including that using such factors may violate ECOA or other laws if they constitute unlawful discrimination on a prohibited basis. 

The Bureau has also clarified that adverse action notice requirements apply equally to all credit decisions, regardless of whether the technology used to make them involves complex or “black-box” algorithmic models or other technology that creditors may not understand sufficiently to meet their legal obligations.[xxii] As data use and credit models continue to evolve, creditors must ensure that these models comply with existing consumer protection laws. 

Jonathan Foxx, PhD., MBA

Chairman & Managing Director 

Lenders Compliance Group

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[i] 15 USC 1691(a)

[ii] 15 USC 1691(d)(2); 12 CFR 1002.9(a)(2)(i); see also 12 CFR 1002.9(a)(2)(ii), which allows creditors the option of providing notice or, following certain requirements, to inform consumers of how to obtain such notice.

[iii] 15 USC 1691(d)(3); 12 CFR 1002.9(b)(2). See also Adverse action notification requirements and the proper use of the CFPB’s sample forms provided in Regulation B, Circular 2023-03, September 19, 2023, Consumer Financial Protection Bureau 

[iv] 12 CFR Part 1002 (Supp. I), § 1002.9, para. 9(b)(2)-2

[v] 12 CFR Part 1002, (App. C), Comment 3

[vi] Like ECOA, FCRA also includes adverse action notification requirements. See 15 USC 1681m(a)(2). 15 USC 1681g(f)(1)(C); see also 1681g(f)(2)(B). 

[vii] See 12 CFR Part 1002 (Supp. I), § 1002.9, para. 9(b)(2)-9

[viii] 12 CFR Part 1002 (App. C), Comment 3

[ix] Adverse action notification requirements in connection with credit decisions based on complex algorithms, Circular 2022-03, May 26, 2022, Consumer Financial Protection Bureau

[x] Idem

[xi] Interagency Statement on the Use of Alternative Data in Credit Underwriting, at 2 , Board of Governors of the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corp, National Credit Union Administration, and Office of the Comptroller of the Currency.

[xii] Joint Statement on Enforcement Efforts Against Discrimination and Bias in Automated Systems, at 3 (April 23, 2023), Consumer Financial Protection Bureau, Department of Justice, Equal Employment Opportunity Commission, and the Federal Trade Commission.

[xiii] Ibid. at 3

[xiv] Op. cit. iv

[xv] 12 CFR Part 1002 (App. C), Comment 4

[xvi] Op. cit. viii

[xvii] Op. cit. ii

[xviii] 12 CFR Part 1002 (Supp. I), § 1002.9, para. 9(b)(2)-4

[xix] FTC v. CompuCredit, Complaint, No. 1:08-cv-1976-BBM-RGV, 34-35 (N.D. Ga. filed June 10, 2008)

[xx] 12 CFR 1002.2(c)

[xxi] Revocations or Unfavorable Changes to the Terms of Existing Credit Arrangements, 87 FR 30097 (May 18, 2022), Consumer Financial Protection Bureau. See also Credit Card Line Decreases, (June 29, 2022), Consumer Financial Protection Bureau.

[xxii] Op.cit. ix

Reconsideration of Value and Appraisal Independence

QUESTION 

We are a large wholesale lender. I am a senior underwriter. Every week, we get requests from our broker partners to have properties reappraised. When the appraisal comes back below what they need, they complain to the Account Executives, who then request that we ask for an appraisal re-evaluation.   

Whether we use an AMC or a staff appraiser, we go through a set of procedures to request a second appraisal review to get a valuation closer to the broker’s expectations. It doesn’t always work out, but sometimes we find deficiencies in the original appraisal report, which, if adjusted for, can change the valuation. 

We have a Reconsideration of Value policy and procedure for this process. Our problem is that the new compliance officer is taking the position that this process interferes with appraisal independence. I would like to know if appraisal independence is compromised by requesting a re-evaluation. 

Does Reconsideration of Value compromise appraisal independence? 

Are there procedures we can implement to avoid compromising appraisal independence? 

ANSWER 

There are risks associated with deficient residential real estate valuations. However, financial institutions may incorporate Reconsideration of Value (“ROV”) processes and controls into established risk management functions.[i] The risk occurs not only in collateral valuation models but also in the risk of discrimination impacting residential real estate valuations. 

One problem in providing guidance to you is that no existing requirements are specific to ROV processes. For purposes of this article, I will define an ROV as a request from the financial institution to the appraiser or other preparer of the valuation report to re-assess the report based upon potential deficiencies or other information that may affect the value conclusion. There is some uncertainty in the industry on how ROVs intersect with appraisal independence requirements and compliance with Federal consumer protection laws, including those related to nondiscrimination. 

Collateral valuations may be deficient due to prohibited discrimination; errors or omissions; or valuation methods, assumptions, data sources, or conclusions that are otherwise unreasonable, unsupported, unrealistic, or inappropriate. The concern is that deficient collateral valuations can keep individuals, families, and neighborhoods from building wealth through homeownership by potentially preventing homeowners from accessing accumulated equity, preventing prospective buyers from purchasing homes, thereby making it harder for homeowners to sell or refinance their homes, and increasing the risk of default. 

Up front, it should be understood that valuations that are not credible may pose risks to a financial institution's financial condition and operations. Such risks may include loan losses, violations of law, fines, civil monetary penalties, payment of damages, and civil litigation. 

Regulatory Framework

There are several regulatory frameworks that, taken together, form the basis for ROV activities. For instance, the Equal Credit Opportunity Act (ECOA), and its implementing regulation, Regulation B, prohibit discrimination in any aspect of a credit transaction. The Fair Housing Act (FH Act) and its implementing regulation prohibit discrimination in all aspects of residential real estate-related transactions. ECOA and the FH Act prohibit discrimination based on race and certain other characteristics in residential real estate-related transactions, including in real estate valuations. 

In addition, section 5 of the Federal Trade Commission Act prohibits unfair or deceptive acts or practices, and the Consumer Financial Protection Act prohibits any covered person or service provider of a covered person from engaging in any unfair, deceptive, or abusive act or practice. 

The Truth in Lending Act (TILA) and its implementing regulation, Regulation Z, establish certain federal appraisal independence requirements. Specifically, TILA and Regulation Z prohibit compensation, coercion, extortion, bribery, or other efforts that may impede the appraiser’s independent valuation in connection with any covered transaction. However, Regulation Z also explicitly clarifies that it is permissible for covered persons to, among other things, request the valuation preparer to consider additional, appropriate property information, including information about comparable properties, or to correct errors in the valuation. 

The appraisal regulations implementing Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 require all appraisals conducted in connection with federally related transactions to conform with the Uniform Standards of Professional Appraisal Practice (USPAP), which requires compliance with all applicable laws and regulations including nondiscrimination requirements. 

Applicable appraisal regulations also require appraisals to be subject to appropriate review for compliance with USPAP. Financial institutions generally conduct an independent review prior to providing the consumer a copy of the appraisal or evaluation; however, an additional review may be warranted if the consumer provides information that could affect the value conclusion or if deficiencies are identified in the original appraisal. 

An appraisal does not comply with USPAP if it relies on a prohibited basis set forth in either the ECOA or the FH Act or contains material errors, including errors of omission or commission. If a financial institution determines through the appraisal review process, or after consideration of information later provided by the consumer, that the appraisal does not meet the minimum standards outlined in the appraisal regulations and if the deficiencies remain uncorrected, the appraisal cannot be used as part of the credit decision. 

Interagency Guidance

The Federal Reserve Board, FDIC, NCUA, and OCC have issued interagency guidance describing actions that financial institutions may take to resolve valuation deficiencies. These actions include the following:

• resolving the deficiencies with the appraiser or preparer of the valuation report; 
• requesting a valuation review by an independent, qualified, and competent state-certified or licensed appraiser; or
• obtaining a second appraisal or evaluation. 

Deficiencies may be identified through the financial institution’s valuation review or consumer-provided information. The regulatory framework does permit financial institutions to implement ROV policies, procedures, and control systems that allow consumers to provide and the financial institution to review relevant information that may not have been considered during the appraisal or evaluation process.

Appraisers and Third Parties 

You mentioned the use of AMCs. You must know that a financial institution’s use of third parties in the valuation review process does not diminish its responsibility to comply with applicable laws and regulations. Moreover, whether valuation review activities and resolving deficiencies are performed internally or via a third party, financial institutions supervised by the Board, FDIC, NCUA, and the OCC are required to operate safely and soundly and in compliance with applicable laws and regulations, including those designed to protect consumers. 

In addition, the CFPB expects financial institutions to oversee their business relationships with service providers in a manner that ensures compliance with Federal consumer protection laws, which are designed to protect the interests of consumers and avoid consumer harm. A financial institution’s risk management practices include managing the risks arising from its third-party valuations and valuation review functions. 

Now to turn to Reconsideration of Value itself in the loan flow process. 

Reconsideration of Value

An ROV request by the financial institution to the appraiser or other preparer of the valuation report encompasses a request to reassess the appraisal report based on deficiencies or information that may affect the value conclusion. A financial institution may initiate a request for an ROV because of the financial institution’s valuation review activities or after consideration of information received from a consumer through a complaint or appeal to the loan officer or other lender representative. 

A consumer inquiry or complaint regarding a valuation would generally occur after the financial institution has conducted its initial appraisal or evaluation review and resolved any issues identified. Given this timing, a consumer may provide specific and verifiable information that may not have been available or considered when the initial valuation and review were performed. Regardless of how the request for an ROV is initiated, a request could be resolved through a financial institution’s independent valuation review or other processes to ensure credible appraisals and evaluations. 

An ROV request may include consideration of comparable properties not previously identified, property characteristics, or other information about the property that may have been incorrectly reported or not previously considered, which may affect the value conclusion. To resolve deficiencies, including those related to potential discrimination, financial institutions can communicate relevant information to the original valuation preparer and, when appropriate, request an ROV. 

Complaint Resolution

At the core of the complaint that triggers the ROV request is the complaint resolution process. Financial institutions can capture consumer feedback regarding potential valuation deficiencies through existing complaint resolution processes. The complaint resolution process may capture complaints and inquiries about the financial institution’s products and services offered across all lines of business, including those provided by third parties, as well as complaints from various channels (such as letters, phone calls, in-person, transmittal from regulators, third-party valuation service providers, emails, and social media). 

Depending on the nature and volume, appraisal and other valuation-based complaints and inquiries can be important indicators of potential risks and risk management weaknesses. Appropriate policies, procedures, and control systems can adequately address the monitoring, escalating, and resolving of complaints, including determining the merits of the complaint and whether a financial institution should initiate an ROV.

Policies and Procedures

With respect to procedures you can implement to avoid compromising appraisal independence, there are several policies, procedures, and control systems that should be considered. I will offer a brief outline of such systemic activities that should be installed in the loan flow process.

Counteroffer or Adverse Action: Timing Requirements

QUESTION 

I am in the underwriting department and have a question about notifying the borrower about our decision to approve or adverse their loan. 

We provide an approval, counteroffer, or we adverse the loan. We underwriters here have a system that does not correctly differentiate the notification timing for counteroffers versus adverse action. But I believe counteroffers get additional time on notifications. 

I think this also has to do with how we define a counteroffer and adverse action. Our system works with a set of rules, and I think the rules are incorrectly defined. So, here are my questions. 

What are the notification requirements for our decision to approve, counteroffer, or adverse a loan? 

What is a “counteroffer?” 

What is “adverse action?” 

ANSWER 

Creditors are subject to specific notification requirements under the Equal Credit Opportunity Act (ECOA) in connection with credit applications, with the notice requirements varying based on the action taken by the creditor and whether the application is for consumer credit or business credit. 

Under the ECOA, there are four notification timing requirements for consumer credit. 

1.    Thirty (30) days after receiving a completed application concerning the creditor’s approval of, counteroffer to, or adverse action on the application; 

2.    Thirty (30) days after taking adverse action on an incomplete application, unless an incomplete application notice is provided under procedures specified in Regulation B, the implementing regulation of the ECOA [see section 202.9(c)]; 

3.    Thirty (3) days after taking adverse action on an existing account; or 

4.    Ninety (90) days after notifying the applicant of a counteroffer if the applicant does not expressly accept or use the credit offered.[i] 

With respect to defining a “counteroffer,” it refers to when a creditor offers to grant credit in a different amount or on other terms than the amount or terms requested by the applicant.[ii] 

You might want to know that, pursuant to the ECOA, a counteroffer need not be held open for any particular length of time.[iii] 

Defining adverse action is a bit tricky, so I will provide what it means and doesn’t mean. 

What does “adverse action” mean: 

1.    A refusal to grant credit in substantially the amount or on substantially the terms requested in an application unless the creditor makes a counteroffer and the applicant uses or expressly accepts the credit offered; 

2.    A termination of an account or an unfavorable change in the terms of an account that does not affect all or substantially all of a class of the creditor’s accounts; or 

3.    A refusal to increase the amount of credit available to an applicant who has applied for an increase.[iv] 

What “adverse action” does not include: 

1.    A change in the terms of an account expressly agreed to by an applicant; 

2.    Any action or forbearance relating to an account taken in connection with inactivity, default, or delinquency as to that account; 

3.    A refusal or failure to authorize an account transaction at the point of sale or loan, except when the refusal is a termination or an unfavorable change in the terms of an account that does not affect all or substantially all of a class of the creditor’s accounts, or when the refusal is a denial of an application for an increase in the amount of credit available under the account; 

4.    A refusal to extend credit because applicable law prohibits the creditor from extending the credit requested; or 

5.    A refusal to extend credit because the creditor does not offer the type of credit or credit plan requested.[v] 

Finally, there is the matter of determining when a notification occurs. Notification occurs when a creditor delivers or mails a notice to the applicant’s last known address or, in the case of an oral notification, when the creditor communicates the credit decision to the applicant.[vi] 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] 12 CFR § 202.9(a)

[ii] 12 CFR § 202.2(c)(1)

[iii] 12 CFR, Supplement I to Part 202 – Official Staff Interpretations § 202.9(a)(1)-5

[iv] 12 CFR § 202.2(c)(1)

[v] 12 CFR § 202.2(c)(2)

[vi] 12 CFR, Supplement I to Part 202 – Official Staff Interpretations § 202.9-3

Reverse Mortgage Discrimination

QUESTION

Earlier this year, our federal regulator alleged that we were discriminating on reverse mortgages based on age. At this point, we are still trying to satisfy their requirements to remedy this issue.

Frankly, I don’t see how a HECM can be a focus of age discrimination since we originate them only for homeowners who are 62 or older. Senior citizens are usually people who are 62 or older.

Also, the regulator told us that our reverse mortgage advertisements had fair lending issues. Those concerns are all resolved now. But I need some clarification about the fair lending implications.

How does fair lending impact reverse mortgages?

And what types of advertisements can cause fair lending violations?

ANSWER

Fair lending compliance certainly applies to reverse mortgages. Just like traditional mortgages, reverse mortgages are subject to federal laws governing mortgage lending, including TILA, RESPA, and fair lending laws such as the Equal Credit Opportunity Act (ECOA). These laws and their respective implementing regulations set forth important protections for all mortgage borrowers, including reverse mortgage borrowers.

But, many protections are not tailored to the unique needs of reverse mortgage consumers. ECOA and its implementing regulation, Regulation B, set forth rules prohibiting discrimination by a creditor based on age (or race, color, religion, national origin, sex, or marital status) with respect to any aspect of a credit transaction. ECOA covers both intentional discrimination (i.e., disparate treatment) and also facially neutral practices that have a disparate impact on a prohibited basis, including age.

Regulation B also prohibits creditors from making statements to applicants or prospective applicants discouraging – on a prohibited basis – a reasonable person from making or pursuing an application.

Reverse mortgages are available only to consumers 62 years of age and older. Generally, the amount a consumer can borrow is partly a function of the consumer’s age. This is permissible under Regulation B. However, fair lending concerns can still arise in the reverse mortgage context. For example, if a lender that offers a range of lending products, including reverse mortgages, were to discourage creditworthy applicants over age 62 from applying for alternatives to a reverse mortgage, the lender could risk violating Regulation B.

State regulators have taken enforcement actions to combat unfair and deceptive marketing of reverse mortgages. Many administrative actions have centered not only on individuals and entities that make unfair or deceptive statements about reverse mortgages but also on those that misrepresent their ability and qualifications to offer reverse mortgages to consumers.

Many reverse mortgage lenders are also subject to UDAAP enforcement actions by the CFPB.[i] Some reverse mortgage lenders may also be subject to enforcement actions by the FTC.[ii]

Reverse mortgage advertisements are often a minefield of fair lending violations. Often, the violative ads confuse the consumer. Other ads tend to cause consumers to misunderstand one or more important features of the loans and the loans’ potential risks.

Here are a few of the fair lending issues we have found in our advertising compliance reviews. Keep in mind that these consumer reactions are in some way caused by the texts, various features, and delivery methods of the advertisements.

·       Advertisements caused consumers to believe that the government provided reverse mortgages and that repayment would not be required, giving the impression that reverse mortgages are not loans. 

·       Some ads caused consumers to mistakenly believed that money received through a reverse mortgage represented home equity they had accrued over time and that there was no reason they would have to pay it back. 

·       Many ads either did not include interest rates or put them in the fine print, leading to consumers finding it difficult to understand that reverse mortgages are loans with fees and compounding interest like other loans. 

·       Certain advertisements were confusing due to being incomplete and inaccurate, such as ads implying or stating that borrowers cannot lose their homes or do not have to make monthly payments. 

·       Many ads claimed that reverse mortgage proceeds were "tax free," thus leading consumers to believe they would not have to pay property taxes. 

·       The bogus claim of "tax free" money was used in ads by giving the impression that reverse mortgages are a government-run program or benefit. 

·       Advertisements using language or images referenced the Department of Housing and Urban Development (HUD) or the Federal Housing Authority (FHA), signaling that the government was funding and operating a reverse mortgage program for senior citizens. 

·       Some advertisements created a false perception by stating or implying that the main benefit of a reverse mortgage was that consumers could remain in their homes "as long as they want" based on ads that said, "the title and deed remain in their name." This implied that having a reverse mortgage meant they could never lose their home. This is false because while reverse mortgage borrowers retain the title and deed, the loans are secured by a lien, and borrowers can, in fact, lose their homes. Reverse mortgage borrowers are responsible for several requirements, including paying property taxes, homeowner's insurance, and property maintenance. Failing to meet these requirements can trigger a loan default that results in foreclosure. 

·       Advertisements hid various terms and conditions in the "fine print." Indeed, in some cases, it is likely that consumers could not even read the ridiculously small fine print in the printed ads, and, for the most part, no consumers could read the fine print used in television ads. Ads that included information about borrower requirements typically did so in the fine print. Fine print generally addressed tax and insurance requirements, property maintenance and residency requirements, repayment terms, and other important loan details. 

·       Advertisements caused consumers to misunderstand the government's role because the ads stated that the loans were "government insured" or a "government-backed program." A few advertisements went so far as to use text and graphics, such as eagles and government seals, to imply that reverse mortgages are affiliated with or offered by the federal government. 

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director 

Lenders Compliance Group

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[i] Dodd-Frank Act § 1031

[ii] 15 USC § 45