Private lenders can be more vulnerable to unintentional redlining than other financial institutions.

In light of current events in our country, it is important to address redlining. Although against the law, redlining happens due to inherent biases by lenders and the commonalities that most borrowers in primarily minority neighborhoods share.

What Is Redlining?
According to Investopedia, redlining “is an unethical practice that puts services (financial and otherwise) out of reach for residents of certain areas based on race or ethnicity.”

The practice dates to the 1930s. Agencies of the federal government drew red lines on maps around urban neighborhoods that were considered higher risk to warn lenders against lending in those areas. This practice was called “du jure” redlining, which referred to governmentally sanctioned discrimination.

This practice was specifically prohibited by both the 1968 Fair Housing Act and the Community Reinvestment Act of 1997. Yet the effects of redlining continue to be felt in those originally affected communities.

The Fair Housing Act and Community Reinvestment Act (CRA) also specifically prohibited reverse redlining, which is the practice of charging higher prices for goods and services in certain neighborhoods than in other neighborhoods. Examples of this would be supermarkets charging higher prices in urban ethnic neighborhoods than it does for the same goods in “better” neighborhoods.

Ongoing Impact
It has been found that the neighborhoods that were redlined in the 1930s are still worse economically than other neighborhoods despite the passage of more than 80 years. In “Who Lends Beyond the Red Line?” Kevin Park and Roberto Quercia conclude that as long as the CRA allows lenders to rely on borrower and neighborhood factors, the CRA has not been effective in changing the availability of loans in previously redlined neighborhoods.

Current government regulations allow a lender to do the following when evaluating whether to make a loan:

• Consider credit history
• Consider income
• Consider property condition
• Consider neighborhood amenities and city services
• Balance its portfolio to avoid concentrations in geographic regions, loan structure and loan type

Banks contend that the barrier to lending in formerly redlined communities relates to credit scores of the borrowers. This becomes problematic because credit scores do not always report rent payments, utility bills and other types of regular payments that non-homeowners pay on a regular basis.

Accordingly, many of the applicants in these communities cannot develop the credit history necessary to create a well-determined credit score. When little credit history is used to determine a credit score, a very minor credit blemish can have a disproportionately large impact. In effect, to get approved for a mortgage loan to buy a house, you must own a house.

De Facto Redlining
As a result, a disproportionate number of applicants in these communities will be denied. This resultant discrimination is called “de facto” redlining. The CRA requires that lenders must work diligently to ensure their mortgage lending marketing and loan decisions do not result in de facto redlining. This includes tracking how loans are approved and denied to ensure there are no discriminatory results, even if no overt or intentional discrimination is engaged in.

Another federal law, the Equal Credit Opportunity Act, prohibits discrimination on account of color, religion, national origin, gender, marital status, age or source of income. Redlining can also include discrimination based on any of these factors.

Writing in a Feb. 2, 2017, article entitled “Redlining:  Everything Old is New Again” for the ABA Banking Journal, Timothy Burniston and Barbara Boccia asserted:

“As a practical matter, the prohibition of discrimination on a prohibited basis relates to any aspect of a credit transaction. It can include marketing, pricing, underwriting, servicing, modifications and collections. Relevant geographies considered in redlining might relate to where a credit applicant currently resides, or will reside, or where the residential property to be mortgaged is located.”

A lender’s behaviors with regard to redlining go beyond a clear geographic demarcation in lending approvals. Any lender behavior that prohibits, limits or denies credit in a predominantly minority neighborhood may be examined. Whether a lender advertises in minority neighborhoods can show an intent to redline. Granting credit under less favorable terms to minority applicants in certain geographic areas than to nonminority borrowers in nonminority neighborhoods (reverse redlining) is also prohibited.

Private Lenders and Redlining
The task of reviewing and ensuring that de facto redlining is not happening within a company is particularly difficult for small private lenders. Private lenders are more likely to fall into illegal activities than banks for several reasons.

First, banks are already highly regulated by both state and federal authorities, so they are less likely to run afoul of the regulations due to constant oversight. Second, banks are large enough to have separate compliance departments and software to assist in staying within the required parameters.

Private lenders, on the other hand, are less likely to be involved with day-to-day regulation and likely to have less sophisticated internal systems than banks. Many private lenders take a more “touchy feely” approach to lending, meaning that every loan gets more personal review and attention than bank loans that are run through an electronic system.

It is imperative, therefore, that a private lender’s marketing and review process
be completely neutral in terms of the borrower’s ethnicity and geography. This can be accomplished by making sure the company’s advertising and marketing is not geographically different within any single metropolitan area. For example, it is fine for marketing in Colorado to be different from the marketing in Pennsylvania, but not OK for marketing in suburban Philadelphia to be different from urban North Philadelphia.

It is also important that lending terms be set forth in a matrix or other informative document that strictly relates to a combination of factors, such as credit score, loan amount, loan term, etc., and that this document is applied neutrally to all applicants, regardless of the geographic location of the property or the borrower. If two identical borrowers of different ethnicities and geographic neighborhoods receive the same loan with the same terms, the private lender should be able to withstand a regulatory review. The key is in being able to show consistent application of written terms.

Finally, if a loan is denied because a lender has too many loans in a single geographic area, that concern needs to be addressed in a written document that explains the decision. And, as loans in the geographic area pay off and the concentration lessens, it is important for the lender to extend additional loans in the area, keeping the concentration consistent. The private lender cannot make a few token loans in an area and think they have satisfied the requirement. They must continue to make loans as older loans pay off.

It has been shown that if the relevant state or federal authorities are given reason to conduct an investigation into a lender’s lending practices, it will examine that bank’s lending practices to minority neighborhoods both subjectively and objectively, by comparing that lender to its peers. If a lender falls below the average of its peers for loans to minorities in minority neighborhoods, it will be subject to further scrutiny and, ultimately, penalties if warranted.

Further investigation by regulators will include an examination of the following:

• Whether a lender has a policy of not lending in specific areas that have a predominantly minority population
• Whether a lender fails to market its loans in minority neighborhoods
• Whether a lender provides a more limited product set in minority neighborhoods or has product terms (such as a minimum loan amount) that tends to disqualify borrowers in those areas
• Whether a lender has no branch offices or broker relationships in or near minority neighborhoods but has branches or broker relationships in predominantly nonminority neighborhoods nearby

Both state and federal governmental agencies continue to seek out violations of the various fair lending regulations. Accordingly, it is incumbent upon lenders to continually evaluate their services, marketing choices, complaints, application volume, underwriting, pricing, loan denial patterns and other discretionary practices that, although not done purposely, could result in de facto redlining. These lenders must also have an in-house review team and compliance management system that ensures no disparities exist and, if they do, to remedy the situation immediately to eliminate any fair lending risk.

Most importantly, lenders must make sure all lending criteria used to evaluate an applicant is neutral in terms of not relying on any prohibited factor of the borrower or geography. The first thing a lender needs to do is recognize and acknowledge that there is likely an inherent bias in the way loans are evaluated and strive to develop systems that compensate for these biases.

Presently, most governmental enforcement action is focused on consumer loans, not on business purpose loans. However, the lending rules that regulate banks and other lenders are not applicable to consumer loans only. They also apply to commercial lending. Accordingly, it is incumbent upon commercial lenders to operate strictly within the regulations to avoid becoming the focus of government regulations.

Like so much in the private lending world, our industry survival depends on our willingness to run our businesses within the existing regulations (scant may they be) to avoid becoming more highly regulated by third parties, including state and federal governments.