Tuesday, November 21, 2017

HMDA, ECOA and What's an Application?... again

Regulators do not understand Pre-Qualifications

Implications for NMLS Call Reporting and HMDA Reporting

Recent discussions make it apparent that regulators do not understand the concept of pre-qualification versus qualification or pre-approval. This is critical given the impending 2018 data recording season, when, with substantially lower reporting thresholds, even the smallest company becomes a potential HMDA reporter with its incumbent responsibilities and tasks.

Make sure you are armed with the facts when confronting a regulator who insists you are under-reporting your call volume or HMDA data.

What is Pre-Qualification?

"Pre"-Qualifying is a prior-to-application discussion of eligibility and rates, applied against published standard qualifying guidelines; ratios, down payment, loan type, and maybe even credit score. This analysis should result in a number; the maximum loan amount a customer could afford. It's not an application and the result states "THIS IS NOT AN UNDERWRITING DECISION", something that you must feature prominently on any correspondence. This is so consumers don't represent or think that they have been approved when they haven't.

Why Do Regulators Think Pre-Qualifications are Applications?

Buried in Reg B (ECOA/Fair Lending) commentary is a statement that has now become the lynchpin for the argument that pre-qualifications are applications. This opinion holds that pre-qualifications if failed, must be disposed of via Adverse Action and consequently are subject to activity reporting.

Comment for 1002.2(f)-3 When An Inquiry Or Prequalification Request Becomes An Application.
 3. When an inquiry or prequalification request becomes an application. A creditor is encouraged to provide consumers with information about loan terms. However, if in giving information to the consumer the creditor also evaluates information about the consumer, decides to decline the request, and communicates this to the consumer, the creditor has treated the inquiry or prequalification request as an application and must then comply with the notification requirements under § 1002.9. Whether the inquiry or prequalification request becomes an application depends on how the creditor responds to the consumer, not on what the consumer says or asks. (See comment 9-5 for further discussion of prequalification requests; see comment 2(f)-5 for a discussion of preapproval requests.) 

This comment illustrates the conundrum because, in this case, the consumer doesn't have to ask (apply) for credit but rather simply be ineligible for financing (according to the comment); the discussion must be treated as an application and denied. It also belies the intent of the pre-qualification which is, by its very nature, a positive discussion of what is possible. Even if the current scenario yields a $500 loan, it's positive, not negative. You CAN offer someone a loan if the income increases by a prospective amount, decrease debts by some prospective amount, save some prospective amount of money, and then identify what the pre-qualification yields. This is the purpose of the pre-qualification discussion - educating the consumer about how he or she should proceed if trying to obtain financing in the future.

This also shows the other flaw in the logic of considering a failed pre-qualification a reportable event; what's the number? It's ZERO! Where do you report that?

A "Failed Pre-Qualification" Doesn't Actually Exist

If we agree with the regulator that declining to issue a pre-qualification is a declined loan, you should consider this instance a "Failed Pre-Qualification." A "Failed Pre-Qualification" doesn't mean you issued a pre-qual that didn't meet the customer's expectations - such as one where the customer was looking at a 500,000 house but could only afford 125,000 - but merely should reflect the result of the qualification calculation, subject to underwriting.  So if they can afford a $500 loan, you should issue a pre-qual for $500 and call it a day - no reporting required. In theory, you should never have a failed pre-qualification under this structure.

Your pre-qualification process must show you are determining a maximum loan amount, not meeting a specific loan request criteria. Once you begin trying to meet a specific criteria, it's no longer a pre-qualification , but a qualification. 

Regulators are Correct About Pre-Approvals and Qualifying

Logically, the regulatory interpretation of pre-qualification activity WOULD be true if we called the process "qualification," eliminating the "pre-," instead. In a qualification exercise you start with a specific number - a desired property or particular loan amount - and work through the prospect's financial profile to determine whether the customer is eligible for that particular number. Results of this process identify, in binary form - YES/NO - whether the prospect can afford or is eligible for that number. In this case, if the borrower has too many debts, or has insufficient income or cash, or because of the limited profile, the credit score is insufficient for this particular instance, you now have a number that you are not eligible for. Either change the number (counter offer) or decline to proceed (adverse action).

Similarly, a Pre-Approval is a loan commitment resulting from a customer's application for a specific amount of financing prior to property selection. A customer submits an application and all supporting documentation which the lender completely processes in the absence of a property - no sales contract and subject to appraisal, title and property conditions. All decisioning rules apply.  If the amount the borrower requests cannot be approved, then the underwriter may counter-offer for different terms, which the customer may accept. If not accepted, the loan must be declined and notices provided. Disclosures, except those which apply to a property, must also be provided.

You Can't Fight City Hall

Sadly, to this date, logic doesn't necessarily dissuade regulators from attempting to corral these innocuous discussions into a regulated process. According to several state regulators and the NMLS, while you don't count pre-qualifications in your call report, you must report declined pre-qualifications.

The golden rule applies. No amount of good reasoning will persuade a regulator, who has made a public determination about a policy, to admit that he or she is incorrect. So if you are in a state where the industry has allowed the regulator to control the definitions of what construes a credit inquiry, then you have to build policies around it, to ensure you comply.

Building a Compliant Pre-Qualification Process

Since this ECOA interpretation can open your business to regulatory scrutiny, you should build a process that inoculates you against under-reporting or fair lending findings. Simply, you could issue a pre-qualification certificate or letter for every single discussion, even if the result included a prospective versus current solution.

  • Generate and retain a copy of all pre-qualification letters/certificates from every discussion.
    •  Create a standard pre-qualification letter or certificate
      • There may be multiple formats
        • as is or
        • prospective
  • If you do not issue a pre-qualification (a failed pre-qualification) you should issue an adverse notice stating "we don't offer any program matching your requirements."  
A defined pre-qualification identifies a potential maximum, but does not state any basis for a declination.