K&LNGAlert. Mortgage Banking/Consumer Finance Commentary. Tennessee Enacts Home Loan Protection Act Same Song, New Verse?

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1 K&LNGAlert JUNE 2006 Mortgage Banking/Consumer Finance Commentary Tennessee Enacts Home Loan Protection Act Same Song, New Verse? In many ways, it s the same old song in Tennessee, which recently enacted an anti-predatory lending law. However, Tennessee House Bill 3597 manages to strike a few new chords, having perhaps taken lessons from some of the big-name acts that preceded it, but arguably stumbling a bit in other areas of its performance. With House Bill 3597, which the Tennessee governor signed on May 26, 2006, Tennessee joins the other twothirds of the states in the country (along with increasing numbers of counties and cities) by enacting its own anti-predatory lending law. The Tennessee Home Loan Protection Act of 2006 (the Act ) becomes effective for loans applied for and closed on or after January 1, It contains many features that are familiar to those buried under proliferating state anti-predatory lending laws. However, it appears at least that Tennessee has learned from certain missteps of their predecessors, as the Act includes more determinative liability than in some other laws, and a safe harbor provision that allows assignees to develop policies against the purchase or assignment of high-cost home loans that contain predatory lending violations (as opposed to the acceptance of any high-cost home loans). 1 However, this law continues the trend of expanding the practices that are deemed predatory lending, and applying the draconian penalties that generally accompany that designation. For example, Tennessee s Act requires a lender or servicer of a high-cost home loan to provide a borrower, upon request, two payoff statements per year, free of charge. While requiring payoff statements is not uncommon in consumer protection statutes, violating the Act s requirement with regard to a high-cost home loan gives the borrower a right to actual damages, costs, and attorney s fees, plus statutory damages equal to the amount of all finance charges and fees paid by the borrower (for willful or intentional violations). While consumer protection laws may impose a fine for failing to provide required statements, the Tennessee Act may deprive the lender of its entire compensation on the loan for such a failure. In addition, the Act addresses false advertising, prohibiting an entity from making any untrue, deceptive, or misleading representations with respect to the sale, distribution, offer, or advertising of any loan, refinance, insurance, or other product or service. The Act imposes a civil penalty of $1,000 for noncompliance with this requirement with each solicitation deemed a separate violation. Thus, anyone who thinks a direct mail flyer (or any representation) was incomplete or inaccurate can potentially launch a class action at $1,000 each! OVERVIEW The Act imposes restrictions on high-cost home loans, the lenders that originate such loans, and those who service and collect on such loans. Depending upon the violation, statutory damages are available for willful or intentional violations, equal to the amount of all finance charges and fees paid by the borrower. However, for a willful or intentional violation of certain provisions of the Act related to making high-cost home loans, the Act also provides for the forfeiture of the remaining interest under the high-cost home loan. The Act imposes liability upon purchasers and assignees of high-cost home loans, but it does not, in itself, impose that liability with regard to home loans in general. Class action damages are expressly not available against assignees, and

2 the Act seeks to limit damages for assignees to the amount required to reduce the borrower s liability under the high-cost home loan so that it is no longer such a loan. The Act does not expressly provide for a borrower to rescind a high-cost home loan. WHO MUST COMPLY WITH THE ACT? Lenders In general, the Act applies to a lender, defined in accordance with regulations under the Real Estate Settlement Procedures Act of 1974 ( RESPA ). As such, a lender is the secured creditor or creditors named in the debt obligation and document creating the lien. In a table-funded transaction, the lender is the person to whom the obligation is initially assigned at or after settlement. In addition, the Act clarifies that the term lender includes a mortgage loan broker as defined in the Tennessee Residential Lending, Brokering, and Servicing Act. Under that law, a mortgage loan broker is any person who, directly or indirectly, for compensation: (1) Solicits, places, negotiates or originates mortgage loans for others (or offers to do so), or (2) Closes mortgage loans, which may be in the mortgage loan broker s own name and are thereafter assigned to the person providing the funding. Servicers Certain provisions of the Act, as explained below, expressly apply to lenders or servicers. The Act defines a servicer as any person who, in the regular course of business, assumes responsibility for servicing and accepting payments for a high-cost home loan. WHAT IS A HOME LOAN AND A HIGH-COST HOME LOAN? The Act generally applies only to high-cost home loans. The Act defines the term home loan for purposes of defining high-cost home loans, but there do not appear to be any substantive restrictions that apply to home loans that are not high-cost home loans, and no applicable penalties. 2 The Act otherwise uses the term home loan for purposes of establishing the parameters of a due diligence safe harbor for purchasers and assignees that seek to avoid liability by refusing to buy high-cost home loans that violate the Act. (The due diligence safe harbor is described below in the section of this newsletter addressing assignee liability.) Home Loans. A home loan is a loan in which: (1) The principal amount of the loan does not exceed the lesser of: (a) the conforming loan size limit for a single-family dwelling as established by Fannie Mae (for 2006, $417,000 for first-lien loans, and $208,500 for subordinate-lien loans), or (b) $350,000; (2) The debt is incurred primarily for personal, family, or household purposes; and (3) The loan is secured by a mortgage or deed of trust on real estate in Tennessee upon which there is located (or is to be located) a structure designed principally for occupancy by one to four families, and that is or will be occupied by a borrower as the borrower s principal dwelling. However, the following types of loans are excluded from the definition of home loan (and thus are generally exempt from the bulk of the Act): 3 (1) A residential mortgage transaction, as defined in the regulations under the Truth in Lending Act ( TILA ). A residential mortgage transaction essentially is a mortgage loan to finance the acquisition or initial construction of a borrower s principal dwelling, and also is generally exempted from the federal Home Ownership Equity Protection Act ( HOEPA ). (2) An open-end credit plan, as defined in accordance with TILA s regulations and official staff commentary. (3) A reverse mortgage transaction, as defined under Tennessee law. 2

3 (4) A construction loan, defined to mean a loan for the initial construction of a borrower s principal dwelling on land owned by the borrower with a maturity of less than 18 months, that only requires the payment of interest until such time as the entire unpaid balance is due and payable, or a fee in lieu of interest. This provision is ambiguous, because a mortgage loan for initial construction otherwise is excluded through paragraph (1), above, without the 18-month limitation on the loan s term, so it is unclear what this fourth exclusion is meant to accomplish. (5) Any loan insured or guaranteed by, securitized for, or sold to a government agency, including HUD, VA, the Tennessee Housing Development Agency, or the U.S. Department of Agriculture. High-Cost Home Loans. A high-cost home loan is a home loan (i.e., excluding purchase money, construction, open-end, reverse, and FHA/VA loans) that exceeds the rate threshold or the total points and fees threshold. Rate Threshold. First, a home loan is a high-cost home loan if its annual percentage rate ( APR ) exceeds HOEPA s APR thresholds, as established in HOEPA s regulations and official staff commentary. Those thresholds currently are 8 percent for first-lien loans, or 10 percent for subordinate-lien loans, over the yield on Treasury securities having comparable periods of maturity as of the 15th day of the month immediately preceding the month in which the creditor receives the application for the extension of credit. Total Points and Fees Threshold. Second, a home loan is a high-cost home loan if it has total points and fees, payable by the borrower at or before closing, that exceed: (A) (B) For loans of more than $30,000: The greater of (i) 5 percent of the total loan amount, as that term is defined and used in HOEPA, or (ii) $2,400; or For loans $30,000 or less: 8 percent of the total loan amount. The Act does not expressly provide for changes in dollar amounts. (While the Act grants the Commissioner of the Department of Financial Institutions (the Commissioner ) the authority to issue rules and to interpret the Act, it is not clear that the Commissioner has the authority to change the dollar amounts.) For purposes of this threshold, the Act defines points and fees generally in accordance with HOEPA regulations and their official staff commentary (with the exception of real estate-related fees, as discussed below). The following fees and charges are included: (i) (ii) (iii) All items required to be disclosed in the finance charge under TILA (except for interest/time price differential); Front-end mortgage broker compensation (see below regarding yield spread premiums); Real estate-related fees under Section 226.4(c)(7) of the TILA regulations, unless (a) (b) (c) The charge is reasonable (the Act clarifies that only the amount of the charge that exceeds the charge for comparable items must be included in the calculation of points and fees), The creditor receives no direct or indirect compensation in connection with the charge, and The charge is not paid to an affiliate of the creditor (but see below); and (iv) Premiums for credit insurance or debt cancellation coverage. The official staff commentary to TILA and HOEPA addresses mortgage broker compensation that is paid by the borrower (and is included in the points and fees calculation) and compensation that is not paid by the borrower (and is not included). That commentary often is cited in support of arguments that back-end broker compensation, or yield spread premiums, are not included in the points and fees calculation under HOEPA. While others have made contrary arguments, by specifically invoking HOEPA s official staff commentary, it 3

4 appears clear, at least, that the Act is intended to be consistent with the interpretation of HOEPA s jurisprudence in this regard, and thus yield spread premiums are not included in the Act s calculation of the points and fees threshold. While open-end credit plans generally are exempt from the Act, they are subject to the Act s prohibitions on structuring loan transactions intentionally to avoid the Act. In that regard, points and fees includes those points and fees that are known at or before closing, plus the minimum additional fees the borrower would be required to pay to draw down an amount equal to the total credit line, in accordance with HOEPA s regulations and the official staff commentary. However, points and fees excludes the following: (1) Up to and including two bona fide loan discount points, which are loan discount points actually paid by the borrower to the lender for the purpose of reducing, and which in fact result in, a bona fide reduction of the interest rate applicable to the loan by a minimum of 25 basis points per discount point; (2) Real estate-related fees listed in Section 226.4(c)(7) of TILA s regulations, that are paid to an affiliate of the lender, and the amount is reasonably consistent with amounts charged for comparable services by a party not affiliated with the lender at the time the loan is made. As mentioned above, only the amount of the charge that exceeds the charge for comparable items must be included in the calculation of points and fees. Thus, the Act is confusing with regard to real estate-related fees that are paid to an affiliate. In one instance, the Act invokes HOEPA s requirement that real estate-related fees paid to an affiliate of the lender (which includes a broker) must be included in the points and fees calculation even if reasonable in amount. However, in the next instance the Act states that points and fees do not include real estate-related fees paid to an affiliate of the lender to the extent they are reasonably consistent with amounts charged for comparable services by an unaffiliated party; only the amount in excess of the comparable amount is included. It appears the Act sought to follow HOEPA to a point, and then veered off course so that it could exclude reasonable real estate-related fees, even if paid to an affiliate. We will have to wait to see, if and when the Commissioner issues regulations, whether he or she clarifies this point. WHAT PRACTICES ARE PROHIBITED OR REQUIRED UNDER THE ACT FOR HIGH-COST HOME LOANS? Below is a list of the prohibited acts or practices or requirements under the Act. These apply to a lender (which the Act defines to include a broker) and, in some instances, a servicer. Encouragement of Default or Skipping Payments. A lender is prohibited from recommending or encouraging default or skipping a payment on an existing loan or other debt before and in connection with the closing or planned closing of a high-cost home loan that refinances all or part of the existing loan or debt. Payoff Statements and Fees. A lender or servicer of a high-cost home loan must provide a borrower (or his or her designated agent), upon request, 2 payoff statements within any 12-month period, free of charge. The payoff statement must be valid for at least 15 days. A lender or servicer may charge a reasonable fee for any additional requests for a payoff statement during a 12-month period. The Act provides that a request for a payoff statement sent to the location designated by the lender or servicer shall be provided within five (5) business days after an authorized request, plus any required fee, is received by the lender. It appears the Act intended to require the lender or servicer to provide the payoff statement within 5 business days of the receipt of an authorized request and any permissible fee. Fees for Release. A lender is prohibited from charging a fee to provide a release upon prepayment of a highcost home loan, except for the actual cost paid to record the release. Anti-Flipping/Reasonable Benefit Upon Refinancing. A lender is prohibited from knowingly or intentionally making a high-cost home loan that refinances, within 30 months, an existing home loan or a high-cost home loan, when the new loan does not have a reasonable benefit to the borrower, considering all the circumstances, including the terms of both the new and refinanced loans, the economic and non-economic circumstances, the cost of the new loan, and the borrower s circumstances. 4

5 Financing Single Premium Credit Insurance. A lender is prohibited from making a high-cost home loan that finances, directly or indirectly, any single premium credit life insurance (as defined under the Tennessee Insurance Code), credit accident, credit disability, credit unemployment, credit property (under which the lender is the primary beneficiary), credit health insurance, any other credit insurance product, or any payments directly or indirectly for any debt cancellation or suspension agreement or contract. However, this prohibition does not apply if: (A) (B) (C) The total benefits payable under all such policies or contracts issued in connection with the loan do not exceed $50,000, The principal amount of financed premiums for the policy or contract is repayable during the term of such policy or contract, and The amount payable under a credit life insurance policy must not at any time during the term of the loan be more than 103 percent of the then unamortized principal balance of the loan. In addition, this prohibition does not apply to the payment or receipt of insurance premiums or debt cancellation or suspension fees calculated on the unpaid balance of a home loan and paid on a monthly basis, or to bona fide credit property insurance required by the Federal Housing Administration ( FHA ) or the Department of Agriculture to be paid in a single premium to the respective federal agency. Ability to Repay. A lender is prohibited from making a high-cost home loan unless the lender reasonably believes at the time the loan is made that one or more of the borrowers, when considered individually or collectively, will be able to make scheduled payments to repay the obligation, based upon consideration of their current and expected income, current obligations, employment status, and other financial resources (other than the borrower s equity in the dwelling which secures repayment of the loan). The Act provides a safe harbor for high-cost home loans for which the borrower has a debt-to-income ratio of 50 percent or less, meaning that a borrower shall be deemed to be able to repay the high-cost home loan if, at the time the loan is consummated, the borrower s total monthly debts, including amounts owed under the loan, do not exceed 50 percent of the borrower s monthly gross income: (i) as verified by the credit application, the borrower s financial statements, tax returns, payroll receipts or third-party income verification; and (ii) as underwritten in accordance with the lender s underwriting guidelines and methodology. However, the Act expressly provides that no presumption of inability to make the scheduled payments to repay the high-cost home loan arises solely from the fact that, at the time the loan is consummated, the borrower s debt-to-income ratio exceeds 50 percent. Financing Points and Fees. A lender is prohibited from directly or indirectly financing, in connection with any high-cost home loan, any points and fees in excess of: (i) for loans more than $30,000, the greater of 3 percent of the total loan amount or $1,500; or (ii) for loans of $30,000 or less, 5 percent of the total loan amount. However, registrants under Tennessee s Industrial Loan and Thrift Company Act may finance points and fees as allowed in that Act. Points and Fees Upon Refinancing with Same Lender/Affiliate. A lender is prohibited from charging a borrower points and fees in connection with a high-cost home loan if the proceeds of the high-cost home loan are used to refinance an existing high-cost home loan with the same lender or affiliate of the lender. However, this provision does not apply to points and fees in connection with any additional proceeds (over and above the amount required to pay off the existing high-cost home loan) received by the borrower in connection with the refinancing. Prepayment Fees. Prepayment fees or penalties may not be included in the loan documents for a high-cost home loan, or charged to the borrower, if the fees or penalties exceed, in aggregate, 2 percent of the loan amount prepaid during the first 24 months after closing. In addition, prepayment fees or penalties must not be included in the loan documents or charged to the borrower in a refinancing of a high-cost home loan if the lender or an affiliate of the lender is the holder of the note being refinanced. 5

6 The Act provides that any refund method that is not permitted under Section (d)(6) and (d)(7) of the HOEPA regulations is prohibited. Section (d)(6) provides that prepayment fees are generally prohibited in HOEPA loans, and that a prepayment penalty includes computing a refund of unearned interest by a method that is less favorable to the consumer than the actuarial method. 4 Section (d)(7) provides, however, that a HOEPA loan may provide for a prepayment penalty (or refund under the rule of 78s, for precomputed loans) otherwise permitted by law under certain circumstances. Thus, the Act appears to provide that a refund of unearned interest calculated under a method that is less favorable to the consumer than the actuarial method is prohibited. Balloon Payments. A lender is prohibited from making a high-cost home loan that contains a scheduled payment that is more than twice as large as the average of the earlier scheduled payments. This prohibition does not apply when the payment schedule is adjusted to the borrower s seasonal or irregular income. Negative Amortization. A lender is prohibited from making a high-cost home loan that contains a payment schedule with regular period payments that cause the principal balance to increase. Acceleration Absent Default. A lender is prohibited from making a high-cost home loan agreement that contains a provision that permits the lender, in its sole discretion, to accelerate the indebtedness. This prohibition does not apply, however, when the repayment of the loan has been accelerated by default. Consolidated Advance Payments. A lender is prohibited from making a high-cost home loan with terms under which more than two periodic payments required under the loan are consolidated and paid in advance from the loan proceeds provided to the borrower. Increased Interest Rate After Default. A lender is prohibited from making a high-cost home loan that contains a provision that increases the interest rate after default, except for any interest rate changes in a variable rate loan otherwise consistent with the provisions of the loan documents, if the change in the interest rate is not triggered by the event of default or acceleration of the indebtedness. Late Fee Restrictions. A lender is prohibited from making a high-cost home loan that provides for a late payment fee that exceeds 5 percent of the amount of the payment past due, or $15, whichever is greater. The late payment fee may only be assessed for a payment past due for 10 days or more. The late payment fee must not be imposed more than once with respect to a single late payment, and no late payment fee is permissible with respect to a subsequent payment that would have been a full payment but for the previous default or the imposition of the previous late payment fee. Disclosure Requirement. A lender is prohibited from making a high-cost home loan unless the lender has given the following written notice, in at least 12-point bold type, to the borrower, acknowledged in writing and signed by the borrower, at least three days prior to consummation (i.e., not later than the time that notice provided by 12 C.F.R (c) is required ): NOTICE TO BORROWER YOU SHOULD BE AWARE THAT YOU MIGHT BE ABLE TO OBTAIN A LOAN AT A LOWER COST. YOU SHOULD SHOP AROUND AND COMPARE LOAN RATES AND FEES. MORTGAGE LOAN RATES AND CLOSING COSTS AND FEES VARY BASED ON MANY FACTORS, INCLUDING YOUR PARTICULAR CREDIT AND FINANCIAL CIRCUMSTANCES, YOUR EMPLOYMENT HISTORY, THE LOAN-TO-VALUE REQUESTED AND THE TYPE OF PROPERTY THAT WILL SECURE YOUR LOAN. THE LOAN RATE AND FEES COULD ALSO VARY BASED ON WHICH LENDER OR BROKER YOU SELECT. IF YOU ACCEPT THE TERMS OF THIS LOAN, THE LENDER WILL HAVE A MORTGAGE LIEN ON YOUR HOME. YOU COULD LOSE YOUR HOME AND ANY MONEY YOU PUT INTO IT IF YOU DO NOT MEET YOUR PAYMENT OBLIGATIONS UNDER THE LOAN. 6

7 YOU SHOULD CONSULT A QUALIFIED INDEPENDENT CREDIT COUNSELOR OR OTHER EXPERIENCED FINANCIAL ADVISER REGARDING THE RATE, FEES AND PROVISIONS OF THIS MORTGAGE LOAN BEFORE YOU PROCEED. THE UNITED STATES DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT (HUD) MAINTAINS A LIST OF CREDIT COUNSELORS IN YOUR AREA. YOU MAY OBTAIN HUD S LIST OF CREDIT COUNSELORS BY CONTACTING HUD DIRECTLY OR BY CONTACTING THE TENNESSEE DEPARTMENT OF FINANCIAL INSTITUTIONS. YOU ARE NOT REQUIRED TO COMPLETE THIS LOAN AGREEMENT MERELY BECAUSE YOU HAVE RECEIVED THIS DISCLOSURE OR HAVE SIGNED A LOAN APPLICATION. REMEMBER, PROPERTY TAXES AND HOMEOWNER S INSURANCE ARE YOUR RESPONSIBILITY. NOT ALL LENDERS PROVIDE ESCROW SERVICES FOR THESE PAYMENTS. YOU SHOULD ASK YOUR LENDER ABOUT THESE SERVICES. ALSO, YOUR PAYMENTS ON EXISTING DEBTS CONTRIBUTE TO YOUR CREDIT RATINGS. YOU SHOULD NOT ACCEPT ANY ADVICE TO IGNORE YOUR REGULAR PAYMENTS TO YOUR EXISTING LENDERS. Notice of Counseling Availability. A lender is prohibited from making a high-cost home loan without first providing to the borrower, in a separate document clearly identified, notice of availability of counselors from third-party nonprofit organizations approved by HUD, a Tennessee housing financing agency, or the regulatory agency that has jurisdiction over the lender. The notice must be provided to the borrower not later than three business days after the application is received or prepared (i.e., the time that the good faith estimate of closing costs required by [RESPA] must be provided to the borrower ). The document must provide either a list of counselors located in the borrower s county or the nearest available county where such counselors are available; or a resource list for HUD, the Tennessee Housing & Development Agency, or the Tennessee Department of Financial Institutions, including toll-free numbers and website information if available to identify such counselors. The borrower must be afforded the opportunity to seek counseling without penalty. Materially Different Settlement Charges Than Disclosed. A lender is prohibited from presenting a borrower with a high-cost home loan at closing with a materially different interest rate, term, type of loan, or settlement charges from the settlement charges disclosed on the last disclosures required by RESPA, without redisclosure not less than one day before closing. For this purpose, materially different settlement charges means that the total settlement charges disclosed on the final settlement statement would exceed the last previously disclosed settlement charges by an amount equal to more than 15 percent in the aggregate. Location of Closing. A high-cost home loan may not be closed in a location other than an office of the lender, the office of any attorney at law licensed to practice in Tennessee, the office of a title insurance company or title insurance agency licensed to do business in Tennessee, the office of a settlement or closing agent, or the commercial office of a mortgage broker. Reporting to Credit Reporting Agencies. A lender or its servicer must report at least quarterly both the favorable and unfavorable payment history information of the borrower on payments due to the lender on a high-cost home loan to a nationally recognized consumer credit reporting agency. Legend on Loan Documents. A mortgage or deed of trust that secures a high-cost home loan must state, on the face of the instrument, the following legend prominently displayed: This instrument secures a high-cost home loan as defined in Tennessee Code Annotated, Title

8 Similarly, each note that meets the definition of a high-cost home loan must state on its face the following legend prominently displayed: This instrument is a high-cost home loan as defined in Tennessee Code Annotated, Title Omitted or Incomplete Terms. A lender is prohibited, in connection with a high-cost home loan, from encouraging or soliciting any person to execute any loan agreement, mortgage, deed, deed of trust, loan application, settlement statement, or other loan or closing document for a high-cost home loan if any material terms of the loan or transaction, including, but not limited to, the duration, interest rate, or fees, are omitted or incomplete. All persons are prohibited from encouraging, soliciting, or conspiring with any other person to violate this prohibition in connection with a high-cost home loan. Post-Closing Modifications. All persons, in connection with a high-cost home loan, are prohibited from modifying (including, but not limited to, any alteration or change) any loan agreement, mortgage, deed, deed of trust, loan application, settlement statement, or other loan or closing document, after the execution of such document, except with the written consent of the person or persons affected by the change, or if a valid power of attorney authorizes the modification. A power of attorney is valid for that purpose if it specifically includes the type or nature of the modification. All persons are prohibited from encouraging, soliciting, or conspiring with any other person to violate this prohibition in connection with a high-cost home loan. Right to Reinstate Without Penalty. If a lender or servicer asserts that grounds for acceleration exist and requires the payment in full of all sums secured by the security instrument of a high-cost home loan, the borrower (or anyone authorized to act on his or her behalf) must have the right, at any time prior to three business days prior to a foreclosure sale, to cure the default and reinstate the loan by tendering the amount or performance. A cure of the default reinstates the borrower to the same position as if the default had not occurred, and nullifies (as of the date of the cure) any acceleration of any obligation under the security instrument or note arising from the default. A borrower s right to cure a default prior to commencing a foreclosure proceeding may not be invoked more than once in any 12-month period To cure the default, a borrower must not be required to pay any charge, fee, or penalty attributable to the exercise of the right to cure the default. However, during the cure period, the borrower is liable for any expenses that are actually incurred to preserve, maintain, or protect the property or the lender s security interest and that are otherwise permitted in the note, deed of trust, or other loan documents. In addition, after a lender publicly files a notice of foreclosure or takes other action to seize or transfer ownership of the home, the borrower is liable for reasonable attorneys fees that the lender actually incurred, based on a reasonable hourly rate and a reasonable number of hours, and a reasonable cost for publishing notice of and conducting the foreclosure sale. WHAT PRACTICES ARE PROHIBITED OR REQUIRED UNDER THE ACT FOR HOME LOANS? Notice of Right to Reinstate. Not fewer than 30 days prior to publishing notice of foreclosure as provided under Tennessee law, or commencing an action for judicial foreclosure, a notice of the right to cure the default must be sent to the borrower informing the borrower of the following: (1) The nature of default claimed on the home loan, and of the borrower s right to cure the default by paying the sum of money required to cure the default. If the amount necessary to cure the default will change during the 30-day period due to the application of a daily interest rate or the addition of late fees, the notice must give sufficient information to enable the borrower to calculate the amount at any point during the 30-day period; (2) The date by which the borrower must cure the default to avoid acceleration and initiation of foreclosure or other action to seize the home, and the name, address, and phone number of a person to whom the payment or tender must be made. The date must not be less than 30 days after the date the notice is sent; (3) That if the borrower does not cure the default by the date specified, steps may be taken to terminate the borrower s ownership in the property by requiring payment in full and commencing a foreclosure proceeding or other action to seize the home; and 8

9 (4) The name and address of the lender or servicer and the telephone number of a representative of such person whom the borrower may contact if the borrower disagrees with the assertion that a default has occurred or the correctness of the calculation of the amount required to cure the default. In paragraph (1), above, which appears in Section 4(b) of the Act, the Act refers to home loan, rather than to high-cost home loan. It is unclear whether, by using that term, the Act really intended to provide Section 4(b) a broader scope than only to high-cost home loans. We note that Section 4(a) of the Act (appearing immediately prior to Section 4(b)) addresses a borrower s right to cure a default and reinstate a high-cost home loan, as addressed above. In any event, the penalties for violating Section 4 of the Act, discussed below, expressly apply only to violations with regard to high-cost home loans, and there are no express penalties under the Act for violating Section 4 with regard to home loans. WHAT OTHER PRACTICES DOES THE ACT ADDRESS? The prohibitions below are not expressly limited to high-cost home loans, or even to home loans, but appear to apply to all types of loan transactions. Structuring a Transaction to Evade the Act. All persons are prohibited from dividing a loan transaction into separate parts with the intent of avoiding the applications or provisions of the Act, and from structuring a loan transaction as an open-end credit plan for the purpose and with the intent of evading the provisions of the Act if the loan would have been a high-cost home loan if it had been structured as a closed-end loan. Persons also are prohibited from engaging in any other subterfuge with the intent to avoid the application or provisions of the Act. False Advertising. With respect to the sale, distribution, offering for sale, or advertising of any loan, refinance, insurance, or any other product or service, the Act prohibits any entity from making, publishing, disseminating, circulating, or placing before the public (or directly or indirectly causing those actions), in a newspaper, magazine, other publication, notice, circular, pamphlet, letter, or poster, or over the Internet or any radio or television, or in any other way, any type of statement containing any representation that is untrue, deceptive, misleading, or that uses the name or logo of any other lender without the express written consent of that lender. For purposes of this prohibition, lender means any bank, savings and loan association, savings bank, trust company, credit union, industrial loan and thrift company, mortgage company, mortgage broker, or any subsidiary or affiliate thereof. The Act provides that each solicitation to an individual in violation of that prohibition is considered a separate act. The Commissioners of Financial Institutions and of Commerce and Insurance, and the Tennessee Attorney General are entitled to enforce that prohibition 6 against any regulated entity within their jurisdiction or against any other person. The Commissioners may issue a cease and desist order or impose a civil penalty of up to $1,000 per violation. In addition, any lender whose name and/or logo is used in violation of that prohibition is entitled to sue for actual damages, statutory penalties of $1,000 per violation, and court costs and attorney s fees. WHAT ARE THE PENALTIES FOR VIOLATING THE ACT? Penalties. The Act provides separate damages and penalty provisions for violating the origination-related provisions and for violating the servicing- or collecting-related provisions of the Act. In general, any lender found by a preponderance of the evidence to have violated the Act with regard to the making of a high-cost home loan, including committing a prohibited subterfuge to avoid the Act, is subject to the following damages and penalties: (1) Actual damages; (2) For willful or intentional violations, statutory damages equal to the amount of all finance charges and fees paid by the borrower, and forfeiture of the remaining interest under the loan; and (3) Costs and reasonable attorney s fees. 9

10 As indicated above, the Act uses the phrase making of a high-cost home loan with regard to those penalties. However, the Act uses the term lender, which is defined to include a broker. Thus, it is unclear whether the penalties enumerated above with regard to making a high-cost home loan also apply to brokers in connection with traditional brokering activities. By contrast, the penalties for a lender that violated the Act in connection with the collecting or servicing of a high-cost home loan are similar, but do not expressly include the forfeiture of interest. Any lender found by a preponderance of the evidence to have, in the collecting or servicing of a high-cost home loan, violated the Act s requirements or prohibitions with regard to payoff statements or releases, late fees, reporting to consumer credit reporting agencies, or the borrower s right to cure the default and reinstate, or the prohibition against subterfuge to avoid the Act, is subject to the following damages and penalties: (1) Actual damages; (2) For willful or intentional violations, statutory damages equal to the amount of all finance charges and fees paid by the borrower; and (3) Costs and reasonable attorney s fees. A court may award punitive damages for violations that it finds are malicious or reckless; those damages are limited to three times the actual damages and the amount of all finance charges and fees the borrower paid, exclusive of costs and reasonable attorney s fees. The Act provides that the loan may be reformed to effect the remedies described above. That provision is unclear, but it appears to allow the lender to apply the amount of the borrower s monetary relief to the amounts the borrower owes under the high-cost home loan obligation, perhaps with any attendant loan reformation necessary (for example, depending upon the loan s calculation of interest). The remedies above are not exclusive and are in addition to any other remedies available to the borrower under applicable law. Any action for damages must be brought within three years from the date the borrower discovered or should have discovered the violation. However, a borrower is not prohibited from asserting a violation of the Act as a defense in an action to collect the debt that was brought more than three years from the date of the occurrence of the violation as a matter of defense by recoupment or set-off in such action. The court may require the borrower to indemnify the defendant for reasonable attorney s fees and costs in the case of actions found to be frivolous or brought for the purpose of harassment. To assert such a claim, the defendant lender or servicer must file a motion with the court and provide at least 15 days after service in which the borrower may respond to deny, withdraw, or amend the complaint. As described below, the Commissioner of the Department of Financial Institutions also has authority, after notice and an opportunity for a hearing, to order restitution for a borrower s actual damages or impose a civil penalty of up to $10,000 per violation, among other enforcement powers. The Act does not expressly provide for a right of rescission for violations of the Act. Cure Provision. The Act provides that a lender or servicer of a high-cost home loan that acts in good faith but fails to comply with the Act will not be deemed to have violated the Act if it establishes that within 30 days of discovery, and prior to the institution of any action under the Act: (1) The borrower is notified of the compliance failure; (2) The lender or servicer has made appropriate restitution to the borrower (meaning the reimbursement of any points and fees, interest, or other charges made by the lender and received from the borrower necessary to put the borrower in the same position as if the loan had been originally made as adjusted in accordance with these provisions); (3) With respect to origination-related violations of the Act (as enumerated in the Act), the lender or servicer makes whatever adjustments are necessary to the loan to either, at the borrower s choice, make the loan satisfy the Act s requirements or change the loan s terms in a manner beneficial to the borrower so that the loan will no longer be considered a high-cost home loan subject to the Act; and 10

11 (4) With respect to servicing- and collecting-related violations of the Act (as enumerated in the Act), the lender or servicer makes whatever adjustments or refunds and/or takes such action as necessary to cure the violation by affording the borrower the rights and benefits provided under those provisions of the Act. Alternatively, if the compliance failure was not intentional and resulted from a bona fide error, notwithstanding the maintenance of procedures reasonably adapted to avoid such errors, a lender or servicer who takes the above actions within 60 days after discovery and prior to the institution of any action under the Act or the receipt of written notice of the compliance failure, will not be deemed to have violated the Act. Examples of a bona fide error include, but are not limited to, clerical, calculation, computer malfunction and programming, and printing errors. Assignee Liability With Regard to High-Cost Home Loans. The Act provides that any person who purchases or is otherwise assigned a high-cost home loan is subject to all claims and defenses with respect to the high-cost home loan that the borrower could assert against the lender of the high-cost home loan. The Act does not define the term assignee or person otherwise assigned a high-cost home loan. The Act specifies that the relief against a purchaser or assignee may be asserted by a borrower acting only in an individual capacity. The Act also limits the damages available against an assignee, by providing that the relief may not exceed the sum of the amount required to reduce the borrower s liability so that it is no longer a highcost home loan, plus the amount required to recover costs, including reasonable attorney s fees. The borrower of a high-cost home loan may assert his or her claim or defense against an assignee after notice of acceleration or foreclosure, asserting a violation of the prohibited or required practices in connection with high-cost home loans (as described above) in an individual action to enjoin foreclosure, or to preserve or obtain possession of the home secured by the high-cost home loan. While the Act enumerates these circumstances, it does not expressly limit the borrower s action to those circumstances; thus, the Act does not expressly limit the borrower to defensive (as opposed to affirmative) claims. The borrower must bring his or her claim or defense against an assignee within three years from the date of occurrence of the violation. However, a borrower is not barred from asserting a violation of the Act s prohibited and required practices in connection with high-cost home loans in an action to collect the debt that was brought more than one year from the date of the occurrence of the violation as a matter of defense by recoupment or set-off in such action, except as otherwise provided by law. However, the Act provides that there is no assignee liability if the purchaser or assignee demonstrates by a preponderance of the evidence that it exercised due diligence, at the time of the purchase of the high-cost home loan or within a reasonable time thereafter, intended to prevent it from purchasing or taking assignment of the high-cost home loan that violates the Act. To take advantage of this safe harbor, the purchaser or assignee must demonstrate that it: (1) Has in place, at the time of the purchase or assignment of the loans, policies that expressly prohibit the purchase or acceptance of assignment, by such purchaser or assignee, of any high-cost home loan containing such violations; (2) Requires, by the applicable purchase contract, that a seller or assignor of such loans to the purchaser or assignee represents and warrants to the purchaser or assignee, as of the applicable sale date, that either: (i) (ii) The seller or assignor will not sell or assign to the purchaser or assignee any high-cost home loan containing such violations; or The seller or assignor is a beneficiary of a representation and warranty from a previous seller or assignor to that effect, and, as a result of its purchase of the loans, the purchaser or assignee is a beneficiary of such representation and warranty; and (3) Exercises reasonable due diligence at or before the time of the purchase or assignment of home loans, or within a reasonable period of time after the purchase or assignment of such home loans, that is intended by 11

12 the purchaser or assignee to prevent the purchaser or assignee from purchasing or taking assignment of any high-cost home loan containing such violations. This reasonable due diligence requirement may be met by employing lender s quality control sampling methodology, and does not require loan-by-loan review. While there are other state anti-predatory lending laws with a safe harbor against liability for assignees with policies that prohibit the purchase or assignment of high-cost home loans, Tennessee is unique, so far, in that it allows assignees to develop policies against the purchase or assignment of high-cost home loans that contain predatory lending violations. The federal bill introduced by U.S. Representative Ney (R-OH) (and others) in March of this year contains an amendment to HOEPA establishing a safe harbor for assignees that, among other requirements, have policies that expressly prohibit the purchase or acceptance of either any higher-cost mortgage at all or any higher-cost mortgage containing violations. However, Tennessee is the first jurisdiction that has enacted a safe harbor for assignee policies against accepting high-cost home loans that contain violations (as opposed to the acceptance of any high-cost home loans). While secondary market participants have reluctantly grappled with the erosion of their holder-in-due-course protections in this arena, at least Tennessee has sought a fairer balance between protecting the consumer and facilitating the flow of mortgage credit. In addition, the Act does not expressly impose assignee liability with regard to home loans that are not highcost home loans, and as mentioned above, it does not expressly provide for a borrower s right of rescission. WHO HAS THE AUTHORITY TO INTERPRET AND ENFORCE THE ACT? As indicated above, the Act grants the Commissioner of the Tennessee Department of Financial Institutions the power to interpret the Act and to enact reasonable, necessary, and proper rules for the administration, enforcement, and interpretation of the Act. The Commissioner also may conduct examinations and investigations of the business and the books, accounts, records, and files of each person subject to the Commissioner s regulatory jurisdiction, or of each person the Commissioner reasonably suspects to be subject to his or her regulatory jurisdiction, and to recover the actual costs for any examination and investigation from that person. The Commissioner also has other investigative powers, such as the power to subpoena witnesses, require the production of evidence, administer oaths, and examine persons under oath in connection with the Act s enforcement. The Commissioner s enforcement powers include (after notice and opportunity for a hearing) the power to issue a cease and desist order; suspend, revoke, or refuse to renew any license or registration the Commissioner has issued; or censure, suspend, or bar an individual from any position of management, control, employment, or other capacity related to activities the Commissioner regulates. The Commissioner also may order restitution for a borrower s actual damages or impose a civil penalty of up to $10,000 per violation. In addition, if the Commissioner finds that the public interest requires immediate action to prevent undue harm to borrowers, the Commissioner may enter an emergency order to be effective immediately and until entry of a final order, after which the Commissioner must promptly afford a hearing, upon application, to rescind the Commissioner s action. The Act provides that the Commissioner s authority, as described above, does not limit the Attorney General s authority to institute or maintain an action within the scope of its authority with respect to practices the Act prohibits. PREEMPTION The Act prohibits all Tennessee counties, municipalities, and political subdivisions from enacting and enforcing ordinances, resolutions, and rules regulating financial and lending activities, including those that disqualify persons from doing business with a city, county, or municipality based upon lending practices or interest rates, or imposing reporting requirements or other obligations upon persons regarding financial services or lending practices of persons or entities, and any subsidiaries or affiliates thereof, who: (1) Are subject to the jurisdiction of the Department of Financial Institutions, including activities subject to the Act; (2) Are subject to the jurisdiction of the Office of Thrift Supervision, the Office of the Comptroller of the 12

13 Currency, the National Credit Union Administration, the Federal Deposit Insurance Corporation, the Federal Trade Commission, or HUD; (3) Originate, purchase, sell, buy, secure, or service property interests or obligations created by financial transactions or loans made, executed, or originated by persons referred to in paragraphs (1) or (2), above, to assist or facilitate such transactions; or (4) Are chartered by the United States Congress to engage in secondary market mortgage transactions. On the other hand, the Act also addresses federal preemption of state lending laws, by stating that it does not apply to the extent it is preempted by, or is in conflict with or inconsistent with, the National Bank Act, the Home Owner s Loan Act, the Federal Credit Union Act, or regulations issued by the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, or the Federal Credit Union Administration, and as interpreted by the federal courts, to national or state banks or trust companies, federal or state savings institutions, federal or state credit unions, or the operating subsidiaries of any of the above. OTHER AMENDMENTS Notice of Judicial or Trust Sales. The Act also amends Tennessee s Judicial or Trust Sales Code with regard to the required notice of sale. The Act adds a requirement that in any sale of land to foreclose a deed of trust, mortgage, or other lien securing the payment of money or other thing of value, or under judicial orders of process, the trustee or other party that sells the property must send to the debtor (and any co-debtor) a copy of the notice otherwise required to be posted and/or advertised. The notice must be sent, by registered or certified mail, return receipt requested, on or before the first date of publication. The notice must be sent to the location of the property and the debtor s last known residence or other address provided by the debtor to the mortgagor or trustee, at least 30 days prior to the publication date, if such residence or other last known address is different from the address of the property. For a co-debtor, the notice must be sent to the codebtor s last known residence address or other address provided to the mortgagor or trustee at least 30 days prior to the publication date, but only if that residence or other address is different both from the property address and from the debtor s address. If you have any questions about the Act or this newsletter, please contact Nanci L. Weissgold ( / nweissgold@klng.com), Kris D. Kully ( / kkully@klng.com), or any other member of our Mortgage Banking Consumer Finance Group. 13

14 ENDNOTES 1 However, the Act still manages to confuse readers. For example, as a matter of the Act s codification, it appears that the legislators intended for the new Act to reside as a new chapter in Tennessee s Title 45, which is its Banks and Financial Institutions Code. There are several cross-references within the Act that indicate that intention. However, the introductory text of the bill the governor signed states that the bill amends Title 47 of the Tennessee Code, which is the state s Commercial Instruments and Transactions Code. If, in fact, the bill is intended to be codified in Title 47, the cross-references throughout the Act to Title 45 create substantial confusion. See also endnote 2. 2 The only other reference to home loans is in the Act s provisions regarding a notice of right to cure a default under Section 4 of the Act. The perhaps inadvertent use of the term home loan in Section 4, along with references to highcost home loans, creates ambiguities with regard to the applicability of that requirement, as addressed in this article under the headings "What Practices Are Prohibited or Required Under the Act for Home Loans?" and "Notice of Right to Reinstate. 3 The prohibitions described below regarding structuring loan transactions with an intent to avoid the Act and regarding false advertising appear to apply to all loan transactions, arguably including those loans that are excluded from the definition of home loan. 4 The term actuarial method means the method of allocating payments made on a debt between the amount financed and the finance charge pursuant to which a payment is applied first to the accumulated finance charge and any remainder is subtracted from, or any deficiency is added to, the unpaid balance of the amount financed. 15 U.S.C. 1615(d); 12 C.F.R (d)(6). 5 As mentioned in a previous endnote, the introductory text of the bill the governor signed states that the bill amends Title 47 of the Tennessee Code. However, the fact that the Act requires a legend on the security instrument and the note that the loan is a high-cost home loan as defined in Title 45 indicates that the legislators intended the bill to be codified in Title 45, and if, in fact, the bill is codified in Title 47, the legends will obviously create incongruities. 6 Actually, the Act provides that those officials have the authority to enforce the provisions of this Act, but since the Act otherwise provides enforcement authority for the Act to the Commissioner of Financial Institutions (as well as the Attorney General), it appears that the Act intended to limit the authority of the Commissioner of Commerce and Insurance, for purposes of the Act, to this false advertising prohibition. 2 Kirkpatrick & Lockhart Nicholson Graham LLP OCTOBER 2005

15 MORTGAGE BANKING/CONSUMER FINANCE PRACTICE Kirkpatrick & Lockhart Nicholson Graham LLP has approximately 1,000 lawyers who practice in offices located in Boston, Dallas, Harrisburg, London, Los Angeles, Miami, Newark, New York, Palo Alto, Pittsburgh, San Francisco, and Washington. K&LNG represents entrepreneurs, growth and middle market companies, capital markets participants, and leading FORTUNE 100 and FTSE 100 global corporations, nationally and internationally. For more information, please visit our website at or contact one of the lawyers listed below. ATTORNEYS Laurence E. Platt Phillip L. Schulman Costas A. Avrakotos Melanie Hibbs Brody Steven M. Kaplan Jonathan Jaffe H. John Steele R. Bruce Allensworth Irene C. Freidel Nanci L. Weissgold Phillip John Kardis II Stephen E. Moore Stanley V. Ragalevsky David L. Beam Emily J. Booth Krista Cooley Eric J. Edwardson Suzanne F. Garwood Anthony C. Green Laura A. Johnson Kris D. Kully Drew A. Malakoff David G. McDonough, Jr Erin Murphy Lorna M. Neill Stephanie C. Robinson Kerri M. Smith Holly M. Spencer Erin E. Troy Staci P. Newman Elwood F. Collins Steve H. Epstein Adiya N. Fitisenko Brian M. Forbes Thomas J. Poletti Thomas C. Russler DIRECTOR OF LICENSING Stacey L. Riggin REGULATORY COMPLIANCE ANALYSTS Dana L. Lopez Nancy J. Butler Marguerite T. Frampton Jeffrey Prost Allison A. Rosenthal Brenda R. Kittrell Joann Kim Teresa Diaz Robin L. Dinneen BOSTON DALLAS HARRISBURG LONDON LOS ANGELES MIAMI NEWARK NEW YORK PALO ALTO PITTSBURGH SAN FRANCISCO WASHINGTON Kirkpatrick & Lockhart Nicholson Graham (K&LNG) has approximately 1,000 lawyers and represents entrepreneurs, growth and middle market companies, capital markets participants, and leading FORTUNE 100 and FTSE 100 global corporations nationally and internationally. K&LNG is a combination of two limited liability partnerships, each named Kirkpatrick & Lockhart Nicholson Graham LLP, one qualified in Delaware, U.S.A. and practicing from offices in Boston, Dallas, Harrisburg, Los Angeles, Miami, Newark, New York, Palo Alto, Pittsburgh, San Francisco and Washington and one incorporated in England practicing from the London office. This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Data Protection Act 1988 We may contact you from time to time with information on Kirkpatrick & Lockhart Nicholson Graham LLP seminars and with our regular newsletters, which may be of interest to you. We will not provide your details to any third parties. Please london@klng.com if you would prefer not to receive this information KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP. ALL RIGHTS RESERVED.