The following is an excerpt from Chapter 12 of Volume II of The Mortgage Professional's Handbook:


Stephen M. McGurl, Managing Director
McGurl Risk Advisors LLC

Exceptions that deviate from standards or best practices created by a lender, such as pricing or credit scores, are not always a bad thing.  They can help to generate business for a mortgage lender by allowing consumers to be approved for a loan.  However, as much as exceptions can aid a consumer, they can also cause a nightmare for mortgage lenders by subjecting them to increased examination scrutiny, fair lending enforcement actions, or supervisory observations.

To achieve fair lending compliance with exceptions by way of exception management and policies, mortgage lenders should understand that exception management generally requires more monitoring than other areas of management, specifically to ensure that comparable individuals are being treated similarly.  Proper monitoring can help a mortgage lender avoid violations and keep them off the radar of regulatory agencies.  Exceptions and discretions are not illegal when it comes to mortgage loan origination; they do, however, draw additional regulator attention to fair lending compliance.

Framework to Ensure Compliance with Exception Management and Fair Lending
First, there is the big picture framework that can also be translated to multiple areas of a company, and is not isolated to just fair lending and exceptions management.   A lender should have a strong compliance management system (CMS) in place.  A successful compliance management system will consist of a lending compliance program, which should include policies and procedures to govern the lending process.  Next, there should be a consumer compliant management program.  This program should respond to individual matters and identify major issues and/or trends that may foreshadow a possible fair lending violation.  In addition, a compliance audit should be conducted by an independent entity on a yearly basis at minimum.  Finally, there needs to be active management from the executive leadership team, as well as Board of Director oversight, to establish clear lines of accountability in the lending process. It is not difficult to imagine how these characteristics of a strong compliance management system can easily translate to other areas of concern for a company, such as additional oversight requirements related to board governance.  

Best Practices to Ensure Compliance with Exception Management and Fair Lending
There are several steps in the loan process that are typically subject to exceptions of established company policies, making them attributable to discrimination risk factors.  These particular steps need to be methodically managed.  The exceptions often involve underwriting, pricing guidelines, marketing plans, servicing, and loan application forms. These exceptions lead to the need for a second tier of compliance that focuses on a more direct framework to help manage the exceptions. An effective framework will ensure that the lender will not face any violations of discrimination when exercising discretion in the loan approval process.

Managing these exceptions will involve using the following best practices:

Have defined policies and approaches for exceptions. Defined policies of special circumstances will demonstrate discipline around treating similarly-situated individuals.  For example, if a lender has a standard threshold of a 620 credit score, a loan officer may be permitted to reduce to 600 when certain factors exist.  If a potential borrower has an even lower credit score of 580, a manager’s approval would be required, and, finally, for a score below 580, review and approval would be required from a company executive, such as a Chief Risk Officer.

Mortgage lenders should implement a reporting system in which the frequency of exceptions can be documented. The frequency reports could include items such as the given number of exceptions or a trend encountered when they are used.  This will allow for policy adjustments to decrease the need of exceptions.

Lenders should analyze why exceptions are being made, specifically looking at what triggers the exception, including, for instance, threshold requirements or accommodating a client who frequently uses the lender to obtain mortgage loans.

The exception-approval process should be well documented through a chain of command structure, commencing with the first time the exception is documented and through to the final individual with company approval authority. Depending on the severity of the exception, there should be various tiers of approval authority required. Each individual file containing exceptions should be documented and should be able to stand-alone in the event an issue arises requiring review of such exception.

Probably the most important step in exception management is a comparative review. It is imperative that companies have a framework to monitor underwriting exceptions to ensure comparable individuals are being treated similarly to help avoid discriminatory impacts.  Implementation of the framework and these types of best practices can help to ensure that, when lenders issue exceptions to loans, whether by credit score, price, or some other factor, the company is mitigating risks that may arise from investigations by regulatory agencies as they relate to fair lender violations. In addition to this framework, a lender can take further steps to combat fair lending violations by acting in a completely transparent manner in its dealing with consumers.

Read the rest of this chapter in The Mortgage Professional's Handbook!

Stephen M. McGurl has been in the mortgage banking industry for 32 years. He spends a great deal of his free time devoted to volunteering and charitable work. As an independent consultant in the financial services industry, Steve runs McGurl Risk Advisors, LLC. His primary focus has been providing solutions in the compliance and fair lending space for banks, government agencies and mortgage lenders. He has worked with numerous firms on consent orders, lawsuits and engagements touching such issues as fair lending, fraud, loss mitigation, MBS representation and warranties breaches, portfolio evaluations and staffing capacity.

His career has afforded him the opportunity to be an executive in operations, retail, and wholesale production and account management at several to-ten lenders. Steve has owned his own mortgage brokerage and understands what is involved in building and operating a business on a daily basis. He is very active with local, state and the national MBA as an instructor and member of numerous committees, including the HUD National Homeownership Strategy (NHS) Education and Counseling Subcommittee.

Steve graduated from the School of Mortgage Banking, received his Certified Mortgage Banker (CMB) designation in 1996, and has consulted for the education program of the Mortgage Bankers Association of America.