Understanding Disparate Impact

Disparate Impact is an extremely important concept within the mortgage industry today.  Disparate Impact is the idea that a policy, while neutral on the surface and applied evenly to all borrowers, has a discriminatory effect on a group.  It is considered unintentional discrimination, however, the results of Disparate Impact litigation can be very harsh.  Disparate Impact cases have been a primary claim by community activist groups as well as various housing and lender regulatory bodies.  Lender’s face multi-million dollar civil money penalties as well as negative headline and reputation risk from Disparate Impact claims.

There are three tests that must be reviewed when considering Disparate Impact cases:

  1. The plaintiff must demonstrate that there is a connection between a lender’s policies or practices and that there is a disparate impact or statistical disparity on the plaintiffs.
  2. The defendant (the lender) must have the opportunity to prove that the policy is necessary to achieve a valid interest. If the lender cannot prove this, then the lender will lose to the plaintiff.
  3. If the lender shows that the policy is necessary to achieve a valid interest, the plaintiff must then show that there is an available alternative practice that has less disparate impact and serves the lender’s legitimate needs. If this cannot be done, the disparate impact claim will fail.

An easy example of a failing claim is minimum credit scores.  If a lender has a  policy that all loans must have a minimum credit score of 620, it may result in more protected class borrowers being denied credit.  This is because, broadly speaking, protected class borrowers have lower credit scores than non-protected class borrower.

However, this claim fails as disparate impact because the secondary market for mortgages will usually have a minimum credit score requirement for loan purchases.  The lender could not sell the loan into the secondary market therefore it would have an impact on the lender’s business.  Regarding the viable alternative, there is not one as the secondary market investors have determined that a certain minimum credit score is needed and there is a correlation between loan performance and a borrower’s credit score.

An example of a successful Disparate Impact claim could be considered job stability.  Many low-moderate income borrowers move from job to job, however, their income is stable.  Lender’s have argued in the past that time on job is an indicator of stable income.  This argument is unsuccessful because plaintiff’s in these cases have been able to document sufficiently that the length of time on job is not important, but the continuity of income is what matters.  In these cases, the plaintiffs have prevailed.

Disparate Impact cases are highly controversial and each complaint stands or falls on its own merits.  Lenders must use extreme caution when developing policies and/or procedures to verify that they do no result in disparate impact.  It is highly recommended that during the required annual review of policies and procedures, a check for potential Disparate Impact cases be considered.

As a further protection against claims of Disparate Impact, a review of a lender’s policies and procedures by a neutral third-party can provide valuable protection against potential claims.  Contact West Beibers at The Commonwealth Group for more information at either wbeibers@thecommonwealth.net or by phone at 901-413-6999 for more information.

The Commonwealth Group – Consultants to the Mortgage Industry