The cost to originate a residential mortgage loan has only increased over the years. Some of these costs are variable with the loan amount; a common example is loan officer compensation. But many of those costs are not; there are certain fixed costs that a lender will incur for every loan that is originated, no matter the loan amount.

This has reached the point where lenders are increasingly wondering whether they can actually make a profit on lower loan amounts. Lenders may say, “if my processing cost is $2,000 per loan and I earn $3,000 for a $70,000 loan sold to an investor, am I actually going to lose money after I include all the other costs?”

This involves several potentially conflicting interests. First, there is an interest in fair lending and providing access to credit for the area your institution serves. At least in certain geographical areas, you might find that lower loan amounts are associated more often with a particular ethnicity, age group, or another prohibited factor per fair lending standards. Second, there is a business’s interest in providing good customer service and making loans to deserving borrowers – and no one is saying that a borrower requesting a lower loan amount is less deserving of a home loan. But third, there is an interest in profitability and in focusing attention on those areas that will best support your financial interests.

Here is my analysis on any bank or other mortgage lender that is considering establishing a minimum loan amount.

Potential for Disparate Impact

Assume your institution decides not to offer loans below $60,000 loan amount. This is likely to have a so-called “disparate impact,” such as affecting a higher percentage of minority than white applicants. Now, the purpose for this policy is legitimate – profitability. But because of the potential disparate impact, an institution needs to justify that there is no less discriminatory alternative available. In other words, knowing that the policy is in place for a legitimate, non-discriminatory, purpose, you’ll need to ask: “Is there any alternative that would accomplish the same goal but have a less discriminatory effect?”

There are many examples of institutions under scrutiny for minimum loan amounts. Back in 2012, the Department of Justice settled with Luther Burbank Savings Bank for setting a minimum loan amount of $400,000, which regulators showed resulted in a very low amount of originations to African American and Hispanic consumers.

Institutions get into trouble when they aren’t able to respond to the following question – “Well why don’t you just charge more?” In other words, from a regulator’s standpoint, a better alternative than denying a borrower is to charge higher origination fees. At least then the consumer has the option and isn’t cut off from access to credit.

At this point in the analysis an institution has two options.

First, you can do the legwork and actually prove that you can’t make money simply by charging more. That’s more difficult than you think, especially for a depository that can hold loans in portfolio. For non-depository lenders, it’s often a little easier because you can document that none of your investors will purchase loan amounts that low.

The second option is to state your policy as follows: “We do not have a minimum loan amount, but we will deny loans that would cross into the high-cost threshold.” This largely accomplishes the original goal anyway, because you’re normally not doing lower loan amount loans. But it’s a very important distinction that you’re not denying them because of the loan amount; you’re denying them because the pricing is so high that it triggers high cost requirements that you aren’t willing to engage in.

Best practice here: If you’re not establishing a minimum loan amount, be very clear about this. When you deny a loan because the price the consumer would have to pay for it to be profitable for you is simply too high (perhaps entering high cost territory), make sure that’s how you document the file. There are too many consumer complaints saying “they denied me for having a low loan amount.” In that case, you’ll need to protect yourself with documentation supporting otherwise.

Ben Giumarra is an attorney and director of legal and regulatory affairs at Embrace Home Loans. He may be reached at bgiumarra@embracehomeloans.com.