The Fair Housing Act and the Equal Credit Opportunity Act prohibit lending discrimination. Although these laws have been in effect for many years, lending discrimination continues to be a cause for national concern. This guide will help lenders compare the treatment of loan applicants and identify differences that may be discriminatory. It offers suggestions on how to correct discriminatory practices and improve fair lending performance.
Part One describes how to compare the experiences of testers to determine if all persons asking about credit are provided equivalent information and encouragement. Such lending tests can be performed internally by the lender or by using an independent contractor. The information provided here on how to plan and manage a pre-application testing program will help an institution decide. Testing can help to detect discrimination or it can reassure an institution that it does not discriminate. Its focus is the point where an applicant inquires about a loan, gathers information and receives counseling or an invitation to apply. Discrimination at this important stage of the loan process occurs before it is captured on paper and often results from how one person treated another. We encourage financial institutions to take whatever steps are necessary, including some form of pre-application testing, to inspect the treatment of potential applicants. It will help to prevent illegal discrimination,
improve customer service and attain lending goals. We also encourage institutions to compare the treatment of applicants after submission of an application through a comparative analysis of loan files. Part Two of the guide suggests one method of comparative file analysis. It also provides examples of how loan product features, underwriting standards, or instances of lender assistance to borrowers can be compared to identify unequal treatment that may constitute discrimination. Disparate treatment may occur among any applicants. However, the risk of disparate treatment occurring is higher among applicants who are neither clearly qualified nor clearly unqualified for a loan as there is more room for lender discretion. The system of comparing loan files set out in this guide helps to identify and evaluate such applications.
Evaluating the results of a comparative analysis of tester experiences or actual loan applications requires identifying the different types of discrimination that may have occurred. Part Two discusses how to identify these including overt or subtle discrimination, disparate treatment, disparate impact, an individual instance of discrimination and a pattern or practice of discrimination. Further, it suggests several corrective actions that may be appropriate to consider depending on the circumstances.
Part Three presents excerpts from other widely distributed fair lending guides that provide information useful to the comparative evaluation process. We encourage lenders to review the guides in their entirety.
As financial institutions and their legal counsel may want to evaluate all aspects of a self-assessment program, Part Four discusses what criteria will be used by the regulatory agencies in taking enforcement actions and seeking remedial measures. It further advises that the agencies must refer evidence of discrimination they may uncover to the Department of Justice or HUD even when discovered through a lender’s self-testing effort. However, voluntary identification and correction of violations disclosed through a selftesting program will be a substantial mitigating factor in considering what further actions might be taken.
Finally, the closing statement of this guide is perhaps the first step that an institution should take to ensure equal treatment of loan applicants. It highlights the importance of providing multicultural awareness, race, gender and handicap sensitivity training to all levels of an institution’s staff.
Self Testing
Self-testing allows an institution to compare, in a controlled manner, the treatment of customers and potential customers. Testing for discrimination can help to find potential problems, or it can reassure an institution that it does not discriminate. In addition, an institution can gain insight into how its lending practices appear from the loan applicant’s perspective, a valuable insight not readily available through other internal audit methods.
What is Pre-Application Testing?
Testing is a way of measuring differences in treatment. A financial institution can use pre-application testing to uncover instances of overt or subtle discrimination against individuals protected under the ECOA and the Fair Housing Act. To detect illegal discrimination, testers visit financial institutions posing as prospective loan applicants. While they do not actually complete a loan application, testers do experience the important pre-application phase of the loan process. After discussing loan possibilities, they objectively document how they were treated and the information given to them by the institution’s personnel.
There are three basic types of tests: paired, multi-layered or sandwich, and complaint.
Paired Testing
A paired test consists of sending two individuals (or two couples) separately to an institution to collect detailed information about its lending practices. The testers pose as potential applicants for the same type of loan.
Example: To test for discrimination based on race, a white tester and a black tester separately visit a lending institution to ask about applying for the same type of loan. They would be provided with similar background information such as family size and employment. The black tester would generally have a slightly higher income and less debt in order to appear better qualified than his or her white counterpart. Otherwise, the individuals selected as testers should be similar in all significant respects except for the variable being tested (e.g., race, gender, familial status, etc.).
Their experiences would then be compared to determine if the individual in the protected class may have been the victim of discrimination. Importantly, in paired tests, the testers usually do not have knowledge of each other or the purpose of the test. Conducting the test in this manner helps ensure the validity of the test by minimizing the potential for bias in recording experiences.
Multi-layered Testing
Multi-layered testing or “sandwich” testing uses three testers, only one of whom is a protected class member. As with paired testing, the testers should be similar except for the variable being tested.
Example: In testing for discrimination based on sex, the first tester would be male, the second tester would be female, and the third tester would be male. Marital status would be the same for all three and the female tester’s qualifications would be slightly better than those of the male testers. This test structure limits non-gender variables leaving gender as the most likely basis for potential differences in treatment. In sandwich testing, as in paired testing, the testers separately ask about similar financing requirements.
Complaint Testing
Complaint testing, unlike the sandwich or paired scenarios, uses a single tester to evaluate the experience of an actual loan applicant who believes that an illegal discriminatory event has occurred. The tester assumes characteristics similar to the complainant’s and attempts to obtain information about the same loan product.
Example: The complainant is Hispanic and believes that his loan application was denied based on his national origin. A white tester would be assigned slightly worse financial and employment qualifications than those of the complainant. The complainant’s experiences at the institution would be compared to the white tester’s experiences to determine if there were any differences in treatment. If the tester is offered a loan or receives better treatment and more information, then the complainant may have been discriminated against on the basis of national origin.
In all three types of testing, paired, multi-layered and complaint, the testers prepare an objective, factual written account of their experiences on a standardized report form.
Self-Testing or Contract-Testing
Lending tests can be performed internally by the lending institution or by an independent contractor. The decision rests with the institution; however, it is important for each institution to weigh the advantages and disadvantages of either selection carefully.
One advantage of in-house testing is that the institution directly controls the program as it hires the testers and analyzes the results. Disadvantages are that the testing program may divert employees from other tasks, and it may be more difficult to keep the testing confidential. In addition, it may be harder to analyze the results objectively. This may be especially true if the reviewer knows the employee who was tested.
The use of an independent contractor, on the other hand, limits the use of an institution’s personnel. Furthermore, objectivity and confidentiality are more easily maintained because fewer people within the institution are privy to testing program information. Disadvantages to using an independent contractor are that their methods may not suit a particular financial institution’s needs, experience levels may vary, and costs may be significant. As testing expertise among contractors varies, it is important to verify a contractor’s experience level, testing methodology and references. For example, a particular contractor’s testing program may only deal with customer service issues and ignore testing for illegal discriminatory lending practices.
The following guide to planning, conducting and evaluating a test are provided for your financial institution’s consideration in developing an internal selftesting program or in evaluating an independent contractor’s program.
Planning the Test
The first step in the planning process is to select a test manager knowledgeable in fair lending and capable of supervising all activities before, during and after the test. Planning should include:
• Researching the financial institution’s loan products, local demographics, HMDA data and other pertinent information
• Determining which type of test to conduct (e.g., paired, sandwich, or complaint)
• Recruiting and training the testers
• Providing testers with a “testing identity” and detailed instructions on how to complete the test
The number of tests that should be performed to determine if a financial institution may have discriminatory lending practices that are illegal will vary according to the institution’s size and loan volume. For example, if testing a multi-billion dollar institution operating in a large metropolitan area, several tests for each branch may be necessary. However, if the financial institution is small or has a low lending volume, more than a few tests may be impractical. The aim is to test a representative sample of an institution’s lending staff over time.
Institution size and loan volume also should determine the frequency of testing. For example, all the testing for race discrimination in a financial institution that typically has few minority loan applicants should not be performed in one week nor should the number of tests each week exceed the institution’s weekly average of loan applications.
