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The Housing Advocates Inc.

Financial institutions can have a great deal of control over the practices of their third-party mortgage brokers, especially for compliance with fair-lending laws, pricing policies and the use of credit-scoring models.

There is a very close relationship among the traditional financial institutions, mortgage brokers and real estate agents. Brokers know where to get their clients financed, and lenders have a history of doing business with certain mortgage brokers and real estate agents. It is a symbiotic relationship. Lenders know who is breaking the law and who is skirting the law. They know who the "bad guys" are. In fact, those were the words used by a mortgage broker who recently confided, "We know in our industry, and certainly the financial institutions know, which mortgage brokers are really doing a disservice to clients."

The reason lenders know the "good guys" from the "bad guys" is that they have dealt with them over a number of years. In a situation where there have been excessive defaults on loans from the same mortgage broker, or if defaults often occur within several months after the loans, it is not difficult for a financial institution to gather evidence of what happened and of potential wrongdoing. There may have been problems with these loans: The applications are being falsified, the income levels are being falsified, the credit report has inconsistencies on it or credit scoring doesn't really match. The credit score is not sufficient to justify the loan.

On the opposite end of the spectrum, it would be relatively easy for financial institutions to identify mortgage brokers who try to maximize their commissions by charging some borrowers more than what is usual and fair in points, rates and fees. These are situations where borrowers should be able to qualify for traditional "A" loans but are being offered subprime "C" loans.

One strategy for the financial institution to avoid third-party liability is to test loan application files. In this fair-lending review, the Truth in Lending Act (TILA) statement and the U.S. Department of Housing and Urban Development's Good Faith Estimate documents regarding the costs of the loan should be examined. Look at the cost of the appraisal and other fees to determine if they may be excessive or unusual. Look for credit life insurance packages built into the loan and see whether the consumer is being required to pay up-front for this credit life insurance or for the life of the loan. If the financial institution begins to see inconsistencies from broker to broker, that should send up a red flag. Such a pattern would result in a closer scrutiny of all new loans being submitted by this particular mortgage broker.

Unfortunately, these predatory lending practices are often being funded by financial institutions. This practice may be driven by the need to comply with their Community Reinvestment Act (CRA) obligations. The act was meant to help meet the credit needs of all communities in a bank's assessment area, including low- and moderate-income (LMI) neighborhoods. However, in a perverse way, the CRA has in some cases had the opposite effect. Banks, rather than trying to find and use their own branch system of loan offices, instead closed down their own branches and limited access and services to these customers. These banks have relied upon third parties, such as mortgage brokers and real estate agents, to generate CRA loans.

Lending to LMI borrowers can be profitable for financial institutions, but it causes severe hardships for the consumer, who is often a minority and/or female head of household. A third-party arrangement allows unscrupulous mortgage brokers or real estate agents to misuse or abuse the system. The banks are really looking at, "Will this help me meet my CRA needs and will it meet our profit motive?" So, when some argue that this third-party system is more efficient, what they really mean is that it is more prof itable. However, this is not necessarily what financial institutions should do if they are going to be good neighbors and good businesses for our community. They need to make a commitment to the community, which was the original purpose of the CRA. It was to require banks to commit themselves to the community, to those areas in their credit service areas that have not been served by them in the past.

What are the risks if financial institutions don't respond to predatory lending issues being raised today? They face new and costly legislative and regulatory initiatives. More importantly, they will face substantial risk of litigation. Unlike TILA or other consumer laws, the federal and Ohio fair housing laws place special obligations on the entire housing industry, including financial institutions. One of these obligations is that the duty of fair housing and fair lending is non-dele-gable. Almost a quarter century ago, in one of the first cases involving a racially discriminatory refusal to make a home loan, our federal court found in favor of the victim of discrimination in John and Susan Harrison, Plaintiffs, v. Otto G. Heinzeroth Mortgage Co. and Otto G. Heinzeroth and John Haugh, Defendants, 430 F. Supp. 893, 896-97 (N.D. Ohio 1977) and held that:

Thus the Court has no difficulty in finding the defendant Haugh liable to the plaintiff. Under the law, such a finding impels the same judgment against the defendant Company and the defendant Heinzeroth, its president, for it is clear that their duty not to discriminate is a non-delegable one, and that in this area a corporation and its officers are responsible for the acts of a subordinate employee, even though these acts were neither directed nor authorized. This ruling troubles the Court to some extent, for it seems harsh to punish innocent and well-intentioned employers for the disobedient wrongful acts of their employees. However, great evils require strong remedies, and the old rules of

the law require that when one of two innocent people must suffer, the one whose acts permitted the wrong to occur is the one to bear the burden of it. [citations omitted]

This decision is not unique in the law. The courts have rejected arguments from real estate brokers that they should not be held liable for the discriminatory acts of their independent agents. (Marr v. Rife, 503 F.2d 735 [6 th Cir. 1974]; Green v. Century 21, 740 F.2d 460, 465 [6th Cir. 1984] ["Under federal housing law a principal cannot free himself of liability by delegating a duty not to discriminate to an agent."]). Furthermore, using the analogy to the Fair Housing Act, the courts have found that finance companies have a non-delegable duty not to discriminate under the Equal Credit Opportunity Act, which cannot be avoided by delegating aspects of the financing transaction to third parties. (Emigrant Sav. Bank v. Elan Management Corp., 668 F.2d 671, 673 [2d Cir. 1982]; United States v. Beneficial Corp., 492 F. Supp. 682, 686 [D.N.J. 1980], aff'd, 673 F.2d 1302 [3d Cir. 1981]; Shuman v. Standard Oil Co., 453 F. Supp. 1150, 1153-54 [N.D. Cal. 1978]).

Now apply this case law to financial institutions that refuse to monitor their relationship with mortgage and real estate brokers. These lenders can be subjected to substantial damage awards. Playing ostrich will not insulate them from any illegal actions of mortgage brokers and real estate agents with which they deal. If there can be shown a pattern and practice, then financial institutions are assumed to have control. They have the ability to say "yes" or "no." They have a right to monitor and determine whether or not these "independent actors" are breaking the law. If they knew or should have known, they can be held liable.

Financial institutions and mortgage brokers should also follow another example of the real estate industry. The larger real estate firms have their own in-house fair housing program to train their staff. Large companies have their own programs because they want to make sure that their real estate agents are aware of the law and of company policies. They want these policies implemented. All employees and independent contractors must know the law, the company's policies and that everyone will uphold fair housing and fair-lending laws.

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