While we do not believe this practice is expressly prohibited or otherwise per se unlawful, it would entail some risk for the bank, and we recommend proceeding with caution if you use this approach.
Adding hypothetical housing expenses to a loan applicant’s DTI calculation has the potential to create a disparate impact on (or to disproportionately exclude) a protected class of citizens. For example, as explained in a National Credit Union Administration (NCUA) opinion letter, this practice could disproportionately exclude younger applicants if applied to all applicants without consideration of their individual circumstances, because younger loan applicants may be more likely to be living with family members who are covering their housing expenses. We also could imagine this practice having a disparate impact based on other characteristics, such as gender, race, or the fact that an applicant receives income from a public assistance program.
These types of disparate impact are not automatically fair lending violations, but such a practice may invite increased scrutiny from your regulators (or the public) based on the same concerns expressed in the NCUA opinion letter. If a regulator were to find that this practice creates a disparate impact on a protected class, you would be required to justify your program based on a business necessity, such as protecting consumers from loans they otherwise could not afford to receive, or safety and soundness concerns for the bank.
If you do proceed with this practice, you should carefully monitor for any signs of disparate impact, and you should carefully document the business necessity for the practice in each circumstance.
For resources related to our guidance, please see:
- Equal Credit Opportunity Act, 15 USC 1691 (“It shall be unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction (1) on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract); (2) because all or part of the applicant’s income derives from any public assistance program
- Illinois Human Rights Act, 775 ILCS 5/1-103 (“‘Unlawful discrimination’ means discrimination against a person because of his or her race, color, religion, national origin, ancestry, age, sex, marital status, order of protection status, disability, military status, sexual orientation, pregnancy, or unfavorable discharge from military service . . . .”)
- NCUA Opinion Letter (March 4, 2005) (“You have asked if a lender’s practice of routinely adding an amount to the debts of a loan applicant who does not report any housing expense is likely to result in a ‘disparate impact,’ a result federal antidiscrimination law prohibits. We think this practice could result in a disparate impact on younger applicants. . . . Accordingly, a lender may consider the circumstances surrounding an individual applicant’s lack of housing expense and may determine the facts in a particular case warrant an adjustment. We believe, however, a blanket policy of adding an amount to every applicant’s debts to compensate for the absence of a stated housing expense is improper and could result in illegal discrimination under the federal fair lending rules.”)
- FFIEC Interagency Fair Lending Procedures, page iv (“When a lender applies a racially or otherwise neutral policy or practice equally to all credit applicants, but the policy or practice disproportionately excludes or burdens certain persons on a prohibited basis, the policy or practice is described as having a ‘disparate impact.’ . . . The fact that a policy or practice creates a disparity on a prohibited basis is not alone proof of a violation. When an Agency finds that a lender’s policy or practice has a disparate impact, the next step is to seek to determine whether the policy or practice is justified by ‘business necessity.’ The justification must be manifest and may not be hypothetical or speculative. Factors that may be relevant to the justification could include cost and profitability. Even if a policy or practice that has a disparate impact on a prohibited basis can be justified by business necessity, it still may be found to be in violation if an alternative policy or practice could serve the same purpose with less discriminatory effect.”)