Mortgage Banking Commentary

Transcription

1 Mortgage Banking Commentary DECEMBER 2001 Through the Looking Glass Predator edatory Lending Legislation in Washington, D.C. by: Costas A. Avrakotos Nanci L. Weissgold The Washington, D.C. City Council voted to suspend D.C. s Protections from Predatory Lending and Mortgage Foreclosure Improvements Act of 2000 (the Act ) for four months. Without the Mayor s signature or veto, the legislation suspending the Act took effect at midnight, November 27, The four-month suspension proved necessary because lenders found the Act unwieldy, with many lenders suspending their mortgage financing activities in D.C. altogether. In enacting the measure last year, the D.C. City Council intended to modernize its antiquated foreclosure laws and supplement its lending laws in order to better protect the interests of D.C. consumers. However, the Act contains a number of provisions that are less than clear and provide severe consequences for noncompliance. As a result, rather than risk converting good faith mistakes into material penalties, many lenders chose to abandon making residential mortgage loans in the District, leaving borrowers with fewer sources of credit. The four-month suspension period will be used to develop legislation with which the D.C. City Council, consumer groups and the mortgage industry can live. D.C. Mayor Anthony Williams has indicated his belief that the four-month suspension is too long, leaving D.C. residents vulnerable to unscrupulous lenders during that period. We may see emergency legislation enacted before the expiration of the four-month suspension. The Mayor planned to introduce emergency legislation by December 4 th. The date, however, now has been extended until December 18 th. What form the emergency legislation will take is unclear. We understand that there are three proposals up for consideration: (i) the Mayor s Task Force revision of the currently suspended legislation; (ii) the proposal by D.C. Councilpersons Cropp and Ambrose which we understand is based on North Carolina s predatory lending legislation; and (iii) a bill drafted on behalf of a coalition of mortgage lenders, which combines elements of Pennsylvania s and New York s predatory lending legislation. Given the possibility that a revised version of the currently suspended legislation may emerge, we believe it is useful to highlight some of the biggest problems contained in the suspended Act: n Guilty Til Proven Innocent The antipredatory provisions of the suspended law apply only to home loans. Under the Act, however, every residential mortgage loan is considered a home loan, until it is proven otherwise. Accordingly, even if a lender is diligent in its efforts to ensure that it does not make home loans, each loan essentially is presumed to be a home loan unless the lender can certify otherwise. With every deed of trust or mortgage on residential real property recorded in the District (not just those that meet the definition of home loan ), lenders are required to file a six-part, thirteen-page Information Form, executed by the mortgage broker, mortgage lender, seller, borrower, and/ or the noteowner or the noteowner s agent. Kirkpatrick & Lockhart LLP

2 Five of the six parts of the Information Form must be notarized separately. The purpose of the Information Form is to determine whether the loan is a home loan, and, if it is, whether it violates the Act s prohibited practice provisions. The penalty for failing to execute the Information Form properly or record the Information Form once completed is severe lenders lose the right to foreclose by power of sale, even if the loan by its terms does not constitute a home loan. Completing and recording the Information Form is a logistical nightmare. Because the Information Form must be recorded in the land records, lenders must rely on title companies to record the document. Some title companies have refused to close a loan until the lender provided a fully executed Information Form. Despite the six-month, post-closing cure period allowed under the Act to supplement the recorded deed of trust or mortgage with the recording of the Information Form, title companies do not want to take on liability for an improperly completed or missing Information Form. Thus, no Information Form, no loan. Moreover, in a table-funded transaction, responsibility for executing certain parts of the Information Form cannot be readily discerned. The line distinguishing broker from lender and noteholder is blurred. The D.C. government could not offer practical advice to clarify this uncertainty, but regulators acknowledged this problem and said they were working on suggested amendments to cure it. One has to ask, why have such an Information Form in any event? Besides clogging up the land records, and increasing closing and recordation costs for consumers, who will look at it? There is little doubt that the delivery, execution and recordation requirements involved with this Information Form will spark an endless stream of questionable litigation. Lenders should not be presumed to violate the District s law with each loan made in the District. They should be able to engage in their lawful mortgage financing activities in the District without being compelled to certify that each loan is not a home loan. Any new n predatory lending legislation would be wellserved without such a cumbersome requirement. Through the Looking Glass Following the definition of home loan and its many exclusions makes Alice s journey through the looking glass a walk in the park. As discussed below, the definition of home loan and exceptions from the definition cover more than five single-spaced pages in the Act and almost seven pages in the regulations. A full paragraph is devoted simply to indicate that to be a home loan the property must be owneroccupied! The definition of home loan is written ambiguously, defining home loan in a limited manner, excluding certain loans that are otherwise covered by the definition, while imposing conditions on certain other excluded loans that are not covered by the definition. Little clarity and certainty are provided under the Act as to the loans covered as home loans. Like Alice trying to make sense of it all, lenders will need to solve the riddle of what is a home loan under the District s Act before they can proceed with their business. Understanding the types of residential mortgage loans included in the definition of home loan is all the more confusing when the types of loans expressly excluded are taken into consideration. The Act excludes loans from the definition of home loan that would not be covered by the home loan definition in the first place, such as certain home equity lines of credit or reverse mortgages. Moreover, many loans excluded from the definition of home loan are excluded only if certain conditions are satisfied. Lenders are kept guessing as to whether loans that are not covered by the definition of home loan remain subject to the Act because the loans do not meet all of the conditions to satisfy the regulatory exclusion under the definition of home loan. A wrong guess and it s off with their heads. The exemptions themselves, as defined, also appear unreliable and may set the stage for arbitrary and capricious enforcement actions. Kirkpatrick & Lockhart LLP 2

3 One example is the exemption for loans made in conformity with a documented loan program of a government sponsored enterprise ( GSE ). This provision seems clear. On its face, a loan made in conformity with a Fannie Mae or Freddie Mac program should be excluded from the definition of home loan, and, thus, not subject to the Red Flag Warning or any of the prohibited practice provisions. However, one sentence buried in the regulations suggests a hidden meaning that could trap the unwary. The regulations provide that [a]ny loan not actually purchased by Freddie Mac or Fannie Mae shall not be exempted under this subsection. Thus, if for some reason the lender determines at closing that a loan originated in accordance with a documented loan program of a GSE cannot be sold to the GSE, the lender violated the predatory provisions by failing to provide the Red Flag Warning within the required time frame. The loan also might contain a provision violating the prohibited practice provisions for a home loan, that otherwise would not apply to a loan not meeting the home loan definition. The lender would be unable to certify, as required in the Information Form, that the loan does not violate the prohibited practice provisions. The lender could be subject to penalties for a loan that was excluded from the definition of home loan when originated. Consequently, many lenders believe that they should provide the Red Flag Warning and comply with the other provisions on all loans in the District, not just those the Act was designed to regulate. Another exemption from the definition of home loan is particularly vexing. Under the exemption, a home loan does not include: [a] first-lien loan and second-lien loan created simultaneously in the same transaction and secured by residential lien instruments encumbering the same residential real property which is the owner s principal dwelling where the primary purchase of the loan is for the refinancing or additional financing of the owner s principal dwelling, with or without improving the owner s n principal dwelling, and where the average home loan adjusted rate for both loans is equal to or less than the home loan reference rate, excluding any loan where the first interest rate adjustment or principal and interest payment amount adjustment is permitted before the fifth anniversary of the date of the note secured by the residential lien instrument; provided, that any loan, commonly referred to as an adjustable rate mortgage, where the first interest rate adjustment or principal and interest payment adjustment is permitted before the fifth anniversary of the date of the note secured by the residential lien instrument, shall not be exempted or used to create an exemption under this subparagraph. The exemption is poorly drafted and hard to follow. To make matters worse, long, convoluted mathematical formulas are required to calculate the home loan adjusted rate and the home loan reference rate. An additional mathematical formula is needed to calculate the average home loan adjusted rate. We have identified some of the issues arising from the definition of home loan and from some of the exemptions from the definition. To top it off, there are another nine exemptions from the definition of home loan that are not covered here. The Mad Hatter kept Alice guessing. The definition of home loan and its exemptions will keep a lender s head spinning. A definition of home loan that is clear and concise will go a long way towards making any new legislation comprehensible, fair, and reduce the risk of unnecessary litigation or enforcement actions. The Weakest Link If a determination is made that the loan is a home loan, the loan and lender would be subject to fourteen specifically enumerated prohibited acts and practices such as a prohibition on encouraging or recommending default on an existing loan, charging single-premium credit insurance, charging prepayment fees, or overcharging for Kirkpatrick & Lockhart LLP 3

4 n a home loan. As many of these prohibited acts and practices apply to the origination of the loan or the contract entered into, the prohibitions would appear to apply to a lender making a home loan. However, the terms lender and making are not defined as expected based on their plain language. Section 601 of the Act specifically provides that [t]he following acts and practices are prohibited and shall be deemed predatory in the making, brokering, arranging, funding, or servicing of a home loan ( making a home loan ) by any mortgage broker, mortgage lender, or other person ( lender ) to any owner, borrower or obligor ( home borrower ). It is worth noting that different definitions of mortgage broker and mortgage lender are contained in the regulations but it is unclear to whom those definitions apply. In any event, as worded in the Act, the prohibited practices might be construed to make an entity involved in a discrete component of the mortgage financing process responsible for violations of another entity in the process. If there is one weak link in the process, all who come in contact with the loan could suffer. For example, few of the prohibited practices apply expressly to mere servicers. Nevertheless, a mere servicer might be construed to be subject to the penalties for a predatory loan for violations that occurred at the time of origination. Moreover, as making a home loan is defined to include an entity funding a loan, an investor in a table-funded arrangement could be responsible for the originating lender s errors. It also is unclear how these prohibited practices will apply to an entity providing a warehouse line of credit. If a source provides the funding for a home loan that was made in violation of one of the prohibited practices, it may find that it also is the source that borrowers will petition for damages. The weakest link in the mortgage financing chain could break the bank for any investor. Keep It Simple and Concise The Act is approximately 129 pages. Regulations and accompanying forms promulgated under the Act run an additional 99 pages. Lenders are overwhelmed by the volume of paper. Granted, not all of the Act relates to predatory lending, as it also recodifies D.C. s real property provisions. However, the predatory lending provisions are dispersed throughout the legislation - the definitions, including the unwieldy definition of home loan, are in the beginning, the Information Form is sandwiched in the middle of the Act and the prohibited practice provisions are towards the end. Moreover, many of the predatory lending provisions are poorly worded, difficult to digest and cumbersome. In contrast, North Carolina s predatory lending provisions run approximately 10 pages, and New York s run approximately 11 pages. Separating the predatory lending provisions from the real property provisions, and clarifying their application, would go a long way towards helping lenders manage their compliance with the legislation. Consumer groups have attacked the lending industry for criticizing the Act and withdrawing from the local market, claiming that such a withdrawal is irresponsible and tantamount to supporting predatory lending. Resorting to such simplistic sound bites belies the real issue. The Act was unintelligible, responsible lenders acting in good faith could not determine the requirements for lawful conduct, and the risks far outweighed the possible benefits. Hopefully, with the D.C. government having gone back to the drawing board, they will come up with a workable solution. * * * * * This memorandum is for informational purposes only. Nothing herein is intended or should be construed as legal advice or a legal opinion applicable to any particular set of facts or to any individual s or entity s general or specific circumstances. If you have any questions about the Predatory Lending Law, please contact one of the members of our Mortgage Banking/Consumer Finance Group. Kirkpatrick & Lockhart LLP 4

5 MORTGAGE BANKING/CONSUMER FINANCE GROUP Kirkpatrick & Lockhart LLP was founded in 1946, and, with more than 600 lawyers, is one of the thirty-five largest law firms in the United States. K&L attorneys are based in ten offices in key U.S. cities Boston, Dallas, Harrisburg, Los Angeles, Miami, Newark, New York, Pittsburgh, San Francisco, and Washington. Our firm represents a broad range of clients in a wide variety of matters, including corporate and securities, e-commerce, investment management, insurance coverage, financial institutions, mortgage banking and consumer finance, creditors rights, intellectual property, tax, labor, environmental, antitrust, health care, and government contracts. More than half our attorneys are litigators. We litigate class actions on a range of financial issues, generally defending financial institutions, broker-dealers, public companies, and investment companies and their officers and directors against claims of violations of securities laws, consumer credit laws, and common law tort and contract claims. You can learn more about our firm by visiting our Internet website at The Mortgage Banking/Consumer Finance Group provides legal advice and licensing services to the consumer lending industry. We counsel clients engaged in the full range of mortgage banking activities, including the origination, processing, underwriting, closing, funding, insuring, selling, and servicing of residential mortgage loans and consumer loans, from both a transactional and regulatory compliance perspective. Our focus includes both first- and subordinate-lien residential mortgage loans, as well as openend home equity, property improvement loans and other forms of consumer loans. We also have experience in multi-family and commercial mortgage loans. Our clients include mortgage companies, depository institutions, consumer finance companies, investment bankers, insurance companies, real estate agencies, homebuilders, and venture capital funds. Members of the Mortgage Banking/Consumer Finance Group and their telephone numbers and addresses are listed below: ATTORNEYS Laurence E. Platt (202) lplatt@kl.com Phillip L. Schulman (202) pschulman@kl.com Thomas J. Noto (202) tnoto@kl.com Costas A. Avrakotos (202) cavrakotos@kl.com Melanie Hibbs Brody (202) mbrody@kl.com Irene C. Freidel (617) ifreidel@kl.com Jonathan Jaffe (415) jjaffe@kl.com R. Bruce Allensworth (617) ballensworth@kl.com Daniel J. Tobin (202) dtobin@kl.com Anthony P. La Rocco (973) alarocco@kl.com Emily J. Booth (202) ebooth@kl.com Eric J. Edwardson (202) eedwardson@kl.com Suzanne F. Garwood (202) sgarwood@kl.com Tara Goebel (202) tgoebel@kl.com Steven M. Kaplan (202) skaplan@kl.com Kristie D. Kully (202) kkully@kl.com Krista Patterson (202) kpatterson@kl.com Carol M. Tomaszczuk (202) ctomaszczuk@kl.com Nanci L. Weissgold (202) nweissgold@kl.com Kirkpatrick & Lockhart LLP 5

6 DIRECTOR OF LICENSING Stacey L. Riggin (202) REGULATORY COMPLIANCE ANALYSTS Dana L. Lopez (202) Nancy J. Butler (202) Susan C. Curtin (202) Joelle Myers (202) Marguerite T. Frampton (202) Jeffrey Prost (202) Sharon L. O Brien (202) sobrien@kl.com LAW CLERKS Mera C. Choi (202) mchoi@kl.com SM Kirkpatrick & Lockhart LLP Challenge us. BOSTON n DALLAS n HARRISBURG n LOS ANGELES n MIAMI n NEWARK n NEW YORK n PITTSBURGH n SAN FRANCISCO n WASHINGTON... 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 with a lawyer KIRKPATRICK & LOCKHART LLP. ALL RIGHTS RESERVED. SM