A national consumer coalition plans to file a series of federal fair housing complaints beginning Monday that challenge a widespread practice by banks and mortgage lenders: requiring borrowers who apply for Federal Housing Administration loans to have FICO credit scores well above the 580 minimum set by the FHA itself for qualified applicants with 3.5% down payments.
The complaints allege that the higher FICO requirements disproportionately discriminate against African American and Latino borrowers, many of whom have credit scores above the 580 threshold set by the FHA but below the 620 to 660 minimums frequently imposed by private lenders. FICO scores run from 300 to 850, with higher scores correlated with lower future risk of default.
Because the FHA insures lenders against losses from serious delinquency or foreclosure, there is “no legitimate business justification” for rejecting applicants solely on the basis of FICO scores that are acceptable to the FHA, the complaints contend.
The identities of the 20-plus mortgage lenders that are expected to be the subjects of fair lending filings were not available in advance. But John Taylor, chief executive of the National Community Reinvestment Coalition, which plans to file the complaints, said they included “large, medium and small banks,” all of which maintain minimum FICO scores higher than what the FHA requires. The coalition represents 600 local and regional consumer, economic development and civil rights groups, and has long been an advocate of equal opportunity in mortgage lending.
According to a draft complaint, the coalition conducted what it called “extensive” blind tests among lenders active in the FHA program. Testers presented themselves to loan officers as financially qualified applicants for FHA-insured mortgages, with FICO scores between 601 and 605. Loan officers routinely informed them that they could not accept applicants with FICOs less than 620.
When applicants responded that they knew the FHA was willing to insure loans for borrowers with credit scores as low as 580, often they were told the same: We require higher FICO scores on FHA loans than the FHA does itself.
Lenders with higher FICO policies “knew or should have known that African Americans and Latinos disproportionately have credit scores between 620 and 580, both within the FHA portfolio” and within the lender’s own market areas, the complaint says. As a result, the complaint argues, these lenders’ policies have “the effect of discriminating” against both groups.
“The insidious part of these policies,” Taylor said, is “not simply that they discourage” minorities from buying homes, but they also are “cutting off refinancings” that might be available via the FHA for homeowners who need loan modifications to avoid foreclosures.
The FHA, which was created by the federal government during the Great Depression, traditionally has been a crucial source of mortgage financing for moderate-income, minority and first-time home buyers.
Asked what he thought about lenders’ independent credit score cutoff limits, FHA Commissioner David H. Stevens said the FICO 580 minimum standard was “based on pretty in-depth analysis of performance data” by borrowers, and represented an acceptable level of risk for the agency consistent with its mission.
In an interview that did not touch on the upcoming fair-lending complaints, Stevens said he had concerns about the negative effects that lenders trigger when they impose stricter credit-score standards on applicants than the minimum required by the FHA. This is especially the case when borrowers’ scores are low not because they are “habitual late payers,” but because they’ve experienced unforeseen economic reverses such as recession-related job losses or uninsured medical bills.
One of the country’s top advisors to FHA lenders, Brian Chappelle, a principal with Potomac Partners in Washington, said banks set higher credit-score limits for sound economic reasons: They are concerned about costly indemnification demands from the FHA and “reputational risk” in the investment community if low-FICO loans go sour. Also, Chappelle said, they don’t want to lose valuable revenue they receive for servicing FHA-insured mortgages that are paying on time.
Terry H. Francisco, a spokesman for Bank of America, one of the highest-volume FHA lenders, confirmed that rationale and said the bank set its own “credit standards based on our best analysis of an applicant’s capacity and willingness to repay the loan.”
Brian D. Montgomery, immediate past FHA commissioner, agreed that the recent “stricter credit” limits have some people asking whether the FHA is still serving its traditional type of borrower. But, he emphasized, the potentially heavy “incremental expenses of managing delinquent borrowers” are the key drivers of rising credit score standards.
Distributed by Washington Post Writers Group.