Predatory Lending and Proposed Changes to RESPA
Sarah Friede, Legal Counsel and Senior Underwriter

Helpful links:

The Coalition for Responsible Lending: www.responsiblelending.org

NC Attorney General, Consumer Protection Division: www.jus.state.nc.us/cpframe.htm

U.S. Department of Housing & Urban Development: www.hud.org

Summary of North Carolina Usury Law (NCGS 24-1 et seq)

Some facts about predatory lending:

In 1999 - $232,000,000 in predatory loans in NC

By 2002 - $100,000,000 reduction in predatory loans, including

a. $29,700,000 in prepayment penalties savings

b. $10,500,000 in excess fees savings

c. $18,600,000 in flipping savings

In 2000, NC consumers saved $41,600,000 in single premium credit insurance.

• Subprime loans are 3 times more likely in low-income neighborhoods.
• Subprime loans are 3 times more likely among elderly consumers.
• Subprime loans are 5 times more likely in black neighborhoods than white neighborhoods.

Three general prohibitions apply to all loans, regardless of interest rate:

• No prepayment penalties on loans of $150,000 or less.
• No flipping (serial refinancing) when there is no material benefit to the borrower.
• No financing of up-front single premium insurance.

High-cost home loan restrictions on loans of up to $300,000

Defining "High cost" loans:

a) loans in which up-front fees exceed more than 5% of the loan amount (excluded from the 5% calculations are escrows, appraisal, attorney, credit report, survey fees, etc., paid to a third party for services; also excluded are yield spread premiums); also considered in high fees are prepayment penalties in excess of 1%.

b) loans with interest rates that are 8% more than comparable Treasury bond rates (approx. 14%).

c) loans with prepayment penalties longer than 30 months or more than 2% of the amount prepaid.

Prohibitions on High-Cost Loans:

a) No financing of up-front fees and insurance premiums.

b) Free credit counseling for borrowers before closing.

c) No balloon payments.

d) No negative amortization loans.

e) No loans without regard to borrower’s ability to repay.

NC Mortgage Lending Act of 2001 adds licensing requirements for mortgage brokers and bankers, as well as loan officers.

Any practice that violates Chapter 24 prohibitions against certain high-cost home loans constitutes an unfair & deceptive act affecting commerce in violation of N.C.G.S. 75-1.1. Provisions apply to anyone who in bad faith attempts to avoid the application by subterfuge.

NCGS 24©(6) prohibits lenders from shifting any loss, liability or claim of any kind to the closing attorney for any violation of Chapter 24.

Other States:

A South Carolina bill signed in June 2003, going into effect on January 1, 2004 will require high-interest rate borrowers to attend free credit counseling and bans flipping.

In Tennessee, a bill seeking to crackdown on predatory lending met with significant opposition in the legislature. Modeled after the NC law, it would prohibit flipping, including the collection of fees for new title insurance policies, and would limit points and fees to 5% of the loan value.

Summary of the Most Common Predatory Lending Practices

Excessive broker compensation

• Abuse of the yield spread premium
• Fees in excess of 8% of the loan

Excessive Points and Fees

• Legitimate fees are usually 1% of the loan.
• Predatory lenders often charge up to 10% in "junk" fees.

Loans that Consolidate Short-Term Debt into Long-Term Debt

While not a predatory practice in and of itself, it can take advantage of borrowers who don’t understand that they’ve pledged the equity in their house to pay for their consumer goods; trades in high monthly payments for abnormally low ones – but costs borrowers twice as much over the long-term.

Balloon Payments

Balloon payments are prohibited by NC law on high-cost loans but remains legal on non-high-cost loans and on all loans in Virginia, Tennessee, and South Carolina.

Balloon payments are a favorite ploy of the predatory lender, selling the borrower on the low monthly payment but not explaining fully that the borrower is gaining almost no equity and must refinance at the end of the term. This type of arrangement can be disastrous for elderly borrowers who will almost certainly not qualify for refinancing at the end of the term unless it’s with the original lender.

Equity Stripping

• Typical clients: elderly clients; equity-rich but cash-poor borrowers; unsophisticated borrowers; borrowers suddenly facing an uncertain future, e.g., serious medical condition.
• Bait & switch monthly payments, interest rate, financed fees, etc.
• Borrowers too desperate or too embarrassed to halt the closing.
• Brokers who promise the borrowers there will be a better refinance in just a few months.

There’s Flipping and Then There’s Flipping…

Two types:

1) Serial refinancing of mortgage loans, with the same high fees each time, leaving the borrower with less & less equity.

2) Quick turnaround on purchase & sale, with a large profit margin and a generously high appraisal; now strictly regulated by HUD on all loans involving federal funds.

Legitimate serial refinancing in this current era of better and better interest rates is not the same as the practice of soliciting consumers to continually refinance loans that over time significantly reduce a homeowners’ equity while putting them further into debt.

Flipping often accompanies loans with junk fees or bait-and-switch loans, in which the borrower expresses concern at closing and is promised by the broker that she can refinance soon at better terms. Flipping also results from phone calls soliciting the borrower with promises of cash out at closing.

Insurance Packing and Payment Packing

"Insurance packing" is the adding on of unnecessary extra fees, usually for credit life insurance and disability insurance, at vastly inflated prices. Lenders put these fees on final closing documents as part of finance charges and try to get buyers to agree to them, thus adding to the overall cost of the loan. Clients wishing for these insurance policies are better off finding an insurance agent of their own.

"Payment packing" is the passing off of bi-monthly payments as payments made on a lower interest rate loan. The borrower makes half-payments every two weeks instead of once per month, amounting to 13 full payments per year and thereby shortening the life of the loan. This can be a great way for consumers to save themselves thousands of dollars in interest payment, but it’s only a legitimate practice if it’s accurate disclosed to the borrowers. This practice, as well as several others that fall into the above categories, led to a $484,000,000 settlement agreement reached by the National Association of Attorneys General and Household Finance. Household told its customers that they had qualified for lower-interest rate loans than they actually got, rather than telling them it was like they got a lower rate.

New on the predator scene: "WE BUY HOMES FOR CASH, "Any house, anywhere, Quick"

This doesn’t fit strictly into the "predatory lending" heading, but it is a common method of perpetrating consumer fraud and often has involved attorneys.

Homeowners deed their property to an individual "broker" who promises to make mortgage payments. The homeowners either remain in the homes and pay "rent" or move out so the house can be rented to a third party. The broker (naturally) fails to make mortgage payments but has collected a tidy sum from the homeowners or renters. When foreclosure rolls around, the homeowners find themselves with no home, stripped of whatever equity they may have built up. There is an ongoing criminal investigation of such a scheme in Wilmington, but as of mid-July the state Attorney General’s office had not been involved in prosecuting any of these brokers anywhere in the state.

Attorneys need to be aware of this possible scam when they are approached – often at foreclosure sales – by brokers looking for someone to prepare their documents.

Proposed Changes To RESPA

The GMPA - Guaranteed Mortgage Package Agreements

HUD’s proposed changes to RESPA would offer "settlement service providers" with the opportunity to replace the Good Faith Estimate (for which there are no penalty provisions if violated) with something called the "Guaranteed Mortgage Package Agreements." Technically, the provisions would allow anyone to package mortgage services as long as there is an interest rate guarantee, but in reality GMPAs will probably be used only by mortgage lenders and brokers. The terms of the GMPA must remain in place for 30 days, and the theory behind it is that it will allow consumers to shop and compare GMPAs to determine the best closing costs.

The GMPA has come under fire from various consumer protection groups because it does not require the itemization of fees but merely provides that if "typical" lender-required charges are left out they must be detailed. Unfortunately, the proposed regulations do not elaborate on what is considered "typical," which could leave consumers comparing apples and oranges rather than apples to apples as HUD intends. Also, the GMPA and ultimately the HUD-1 detail only the total cost, not the itemized breakdown. The consumer will not be informed or either the cost or the provider of required services.

In addition, small businesses in the mortgage service field have attacked the plan as being all but guaranteed to drive them out of the field altogether. Large lenders, looking for the cheapest package to offer consumers, will drive down prices offered by service providers such as surveyors, appraisers, and attorneys. It will be like small business either agreeing to have a small shop open inside a Super Wal-Mart or go out of business if they won’t.

Federal Home Ownership and Equity Protection Act of 1994 (HOEPA)

The HOEPA seeks to protect consumers in high-cost loans by addressing unfair and deceptive trade practices and amending Truth-In-Lending Act requirements. The protections of the Act are most commonly referred to as "Regulation Z," under Section. 32. (12 CFR226 et seq).

For first-lien deeds of trust, HOEPA and Regulation Z come into effect when the APR exceeds by more than 8% the rates on Treasury securities of comparable maturity. On second-lien deeds of trust, they come into play when the interest rates exceed by 10% Treasury securities.

Regulation Z requires certain disclosures at least 3 business days before closing:

• Written notice stating that loan need not be completed;

• Statement that the borrowers may lose their house (plus their equity) if they fail to make payments; and

• States the APR, regular payment amount, loan amount; and the maximum monthly payment possible under the adjustable rate (if applicable).

Certain loans are prohibited altogether under HOEPA:

1) All balloon payments for loans of less than 5 years (except bridge loans to buy or build).

2) Negative amortization loans (which increase total principal debt) .

3) Default interest rates higher than pre-default rates.

4) Rebates of interest upon default calculated by any method less favorable than actuarial method.

5) A Repayment schedule consolidating more than 2 periodic payments that are to be paid in advance from the proceeds of the loan.

6) Prepayment penalties, with the following exceptions:

a. The borrowers’ total monthly debt is less than or equal to 50% of monthly gross income;

b. The borrower acquires the money to prepay from a source other than the lender or an affiliate; or

c. The lender exercises the penalty clause during first 5 years of the deed of trust.

7) Due-on-demand clauses, with the following exceptions:

a. Borrower committed fraud or materially misrepresented facts to the lender;

b. Borrower fail to meet payment terms; or

c. Borrower acts in any manner that adversely affects creditor’s security.

8) The refinance of a loan protected by HOEPA into another HOEPA loan within 12 months of the first loan, unless in consumer’s best interest.

9) Loans structured as open-ended (i.e., a home equity loan) if there’s no reasonable expectation that there will be repeat transactions.

Remedies: HOEPA provides for remedies that seek to make the borrowers whole, such as statutory damages, actual damages, court costs, and attorney fees. Truth-In-Lending violations allow for rescission of the loan for up to 3 years.

Private Mortgage Insurance

Homeowners Protection Act of 1998

This law applies to all single-family home loans signed on or after 7/29/99, but not FHA or VA loans or lender-paid PMI loans, and was designed to curb the abusive practices some lenders were engaging in by charging consumers for PMI when it was no longer necessary.

Termination of PMI:

PMI terminates automatically upon reaching 22% equity based on original property value (if payments are current).

PMI cancels upon request at 20% if payments current.

The HPA makes an exception for high-risk borrowers or loans, loans for which payments were not current any time during 12 months before time for termination/cancellation, or if there are liens against property other than the lender’s lien.

Lender Requirements:

Lenders must tell new borrowers at closing and once per year about termination and cancellation provisions.

Mortgage servicers must provide borrowers with a telephone number for information about termination and cancellation.

Lenders or mortgage services must tell borrowers about their rights under loans excluded from the Act, such as those established by contract or state law.

Manufactured Home Sales

According to Consumers Union, almost half of all consumer complaints involving manufactured homes allege dealer fraud or misrepresentation. (July 2003)

Verify with your clients that:

1) The house is the same make, model, year, and size they agreed to buy. (This also includes making sure they were approved for the home they wanted, rather than approved only for a "bait and switch" house.)

2) The clients have seen and inspected the house and are satisfied with the condition.

3) The salesperson did not falsify any loan application information, including down payment or taking the down-payment as a sales fee.

4) The actual price of the home is the price as originally quoted.

5) The terms and conditions of the sale are the same or better than discussed.

6) There are no additional costs, fees, or higher interest than agreed. Examples of costs & fees include insurance, warranties, property insurance, and home or appliance repair plans.

7) The clients did not sign any blank documents.

8) The dealer provided the borrowers with copies of contracts and other sale documents.

UPDATE on the Proposed RESPA Changes:

On July 30, several consumer groups wrote a letter to HUD Secretary Mel Martinez, criticizing the two-package GMPA alternative ALTA has proposed for HUD’s consideration. The two-package approach would allow title insurance providers and other professionals, such as attorneys, to opt-out of the lender packages and create their own package. It would allow consumers the opportunity to select the professional providers of their choice, and also give greater flexibility by allowing them to customize their own total package. Consumer groups, echoing the arguments of the mortgage banking industry, argued to Secretary Martinez that the two-bundle approach will be more costly to consumers, more confusing to consumers, and could result in problems because the title insurer and settlement agent might be "unacceptable" to the particular lender. ALTA fired back with a detailed letter that can be viewed at ALTA’s website, www.alta.org. Among other arguments, ALTA insists that HUD has no authority to revise RESPA in such a manner as to allow lenders to avoid the anti-kickback and disclosure provisions of Section 8.

Statewide Title has also drafted a letter to Senators Edwards and Dole, urging them to support ALTA’s position for the betterment of small service providers and consumers in North Carolina. A copy is available upon request from any of our Statewide offices.