Winter 2001
A professional publication issued by
Cohn, Goldberg & Deutsch, LLC
Serving the legal needs of lenders and servicers throughout Maryland and the Disctrict of Columbia.
Sub-Prime vs. Predatory Lending
Williams
vs. First Government Mortgage
Dr. Seuss once wrote, From there to here. From here to there.
Funny things are happening everywhere. Perhaps that is what is
happening in the judicial system when it comes to sub-prime
lending. As a result of a regulatory push to increase access to
homeownership by lower income groups, sub-prime lending has
flourished. These programs provide credit to borrowers with past
credit problems and who cannot otherwise qualify for conventional
prime lending products. Refinancing is a major component of this
type of lending. In fact the number of sub-prime refinancing
loans, which account for more than 80 percent of all sub-prime
loans, increased ten fold between 1993 and 1998 to more than
790,000. According to HUD, sub-prime lenders increased their
market share in the District of Columbia from 1.4% of all
conventional loans in 1983 to 10.2% in 1998. Moreover, since many
of the sub-prime loans are made to low income and other borrowers
whose economic circumstances and credit ratings are not the best,
they are required to accept more onerous loan terms to gain access
to funds. As a result, sub-prime loans are often labeled
predatory. In fact HUD and the Department of Treasury issued a
joint report detailing legislative and regulatory recommendations
including lowering the target of Homeownership and Equity
Protection Act (HOEPA) triggers, increasing damages and penalties
for violations of TILA and RESPA and restricting the financing of
points and fees under HOEPA. Once the term predatory is accepted
by court, Lenders have been successfully targeted. Lenders have
also seen litigation under a number of consumer protection
theories such as not originating loans to qualified candidates or
not opening offices in low income areas. Under the theory of
further restricting the granting of predatory loans, lenders are
now being possibly subjected in the District of Columbia, to
judicial decisions and proposed legislation which if enacted would
cause an even more, unfriendly lending environment. The proposed
legislation has six key purposes: (1) prohibiting predatory
lending; (2) defining a subset of loans which might be predatory;
(3) codifying a new foreclosure process; (4) providing an extended
right for reinstatement; (5) auditing all foreclosure sales for
compliance and (6) expanding the Districtıs real estate financing
laws to include the Restatement of the Law of Property. The
crucial question is whether the term predatory is accurate. Have
we reached the point where a lender can be successfully sued for
not granting a loan as well as granting one? The answer may be
yes.
On August 1, 2000 a lender was successfully sued in the
United States Court of Appeals for the District of Columbia under
the theory that it originated a predatory loan to a low income
borrower. Williams vs. First Government Mortgage and Investors
Corporation, 97-7195. In Williams, the facts were that the
borrower was a 61 year old retired painter and handyman. He owned
his own home in the District for 29 years. In 1994, the borrower
had a $42,000 mortgage from Central Money Mortgage Company and
paid $587.00 per month. Because he owed $1,400 in unpaid property
taxes, the D.C. government advertised his house for auction in a
tax sale. Not being able to pay the $1,400, the plaintiff went to
several lenders, including seven banks, seeking a $1,400 loan. He
was repeatedly denied credit, mostly for the reason that his
income was too low. First Government offered to help by
refinancing his existing mortgage by increasing the new loan
amount by the amount necessary to pay the outstanding taxes,
various other fees and a two year life insurance policy. As a
result, a new 30 year loan in the amount of $58,300.00 with a 13.9
interest rate and $686 monthly payments was originated. Although,
the monthly payment was $100 more than he had been previously
paying and the term was extended Williams accepted this loan
believing he had no other alternatives except losing his home to
tax sale.
At the time of closing, Williams was receiving $1,072
a month in disability benefits, $100 of which went to health
insurance, plus up to $3,000 a year from part time work. The court
stated that he had roughly $1,200 a month in disposable income
over half of which went to First Government to cover his monthly
payments. This left little more than $500 each month to buy
necessities for himself and his dependents. The court noted that
he had 11 children and 23 grandchildren with his household having
at least seven people in it at any given time. The court, however,
failed to note that his grown children and grandchildren also
contributed rental monies toward the household income.
The
Plaintiff, Williams kept up with his loan payments for 12 months
but his financial condition worsened. The court noted that he
began to run out of food by the later part of each month. His
electricity, gas and water were cut off and eventually he began
missing payments. Williams filed suit to enjoin the foreclosure
and rescind the loan. He also sought damages pursuant to statutory
and common-law causes of action. Specifically, he alleged in part
that First Government violated section 28-3904(r) of the D.C.
Consumer Protection Procedures Act (CPPA) by knowingly taking
advantage of his inability to protect his interests in the loan
transaction or in the alternative by knowingly making him a loan,
that he could not repay with any reasonably probability. After a
five-day trial, the jury returned a verdict in favor of Williams
on his CPPA claim in the amount of $8,400. After trebling the
jury's award to $25,200 as authorized by section 28-3905(k)(1) of
the CPPA, the court awarded attorney fees of $199,340. The court
noted that the award of attorney fees does not have to be
proportionate to the amount of damages awarded. The court also
noted that First Government should have taken into consideration
that the borrower was disabled and that as he got older he would
be unable to supplement his fixed income with earnings from part
time work though-out the 30 year loan term. Moreover, the court
stated, First Government should also have taken into account that
the Plaintiff was unable to fully understand the transaction since
he only had a sixth grade education from the segregated schools of
Savannah, Georgia and that he could read no more than 40 percent
of the newspaper. Other facts the court noted, were that only
recently had the borrower learned through tutoring what S means at
the end of the word and what a capital letter means, that he
thought an interest rate of 13.90 percent exceeded 13.9 percent
and that when he bought his house in 1970, he depended on his wife
basically to do most of his reading at the closing.
It appears
that the law in the District of Columbia has now transformed the
relationship between a lender and borrower into that of a
fiduciary and beneficiary. This seems to have evolved from the
ever, increasing compliance issues that have arisen over the past
few decades. For instance, compliance has been affected by the
Truth in Lending Act and its accompanying Regulation Z (1968), the
Fair Housing Act (1968), the Fair Credit Reporting Act (1971), the
Real Estate Settlement Procedures Act (1974), the Equal Credit
Opportunity Act (1974), the Home Mortgage Disclosure Act (1975)
and the Fair Debt Collection Practices Act (1978) and the Truth in
Lending Simplification and Reform Act as part of the Depository
Institutions Deregulation and Monetary Control Act of 1980.
However, good faith efforts to comply with these rules normally
went unpunished. In 1994, as a result of Rodash vs AIB Mortgage
Co., the environment became substantially more difficult when the
remedy of rescission was established as a result of the lender's
failure to include a third party's $22 Federal Express charge in
the finance charge calculation. However, in 1995 lenders received
relief when TILA was amended to reduce a creditor's liability for
minor inaccuracies. More recently, the Financial Services
Modernization Act, otherwise known as the Gramm-Leach Bliley Act
of 1999, (effective November 12, 2000, requiring financial
institutions to disclose their policies and practices on
disclosure of non-public personal information to third parties),
class action lawsuits regarding issues such as Yield spread
premiums, add-on fees or force placed insurance, have caused the
lending environment to become even more unfriendly. The basis
premise, however, has always been that a borrower was responsible
for his own actions, and that, once reasonably informed about the
cost of credit they were bound by their decision. Under the
Williams rationale, the environment has changed once again to one
that is at the least a role of self policing.
Is there a fine
line between predatory lending and lending to individuals with
less than perfect credit? Perhaps what the judiciary is now
instructing lenders is that they would rather a sub-prime borrower
is denied credit then given a loan that might just give them a
second chance in maintaining ownership of their home but which may
also extend the borrower's agony. On the other hand, a lender must
be sure that it does not deny credit wrongfully. The key to the
answer may be in pricing and in the establishment of clear and
unambiguous definitions and standards as to what constitutes an
acceptable loan versus a predatory one.
Predatory lending is
often used to refer to loans that have been originated and that
contain one of the following characteristics:
- Loans made in reliance on the value of the borrower's home, without considering
the borrower's ability to repay
- Targeting borrowers who are
less financially sophisticated or otherwise vulnerable such as the
elderly or borrowers living in low income areas
- Inadequate disclosures of the loan's cost or risk
- Practices that are fraudulent, coercive, unfair or deceptive
- Terms and structures
that make it difficult for borrowers to reduce their
indebtedness
- Aggressive marketing tactics
- Bundling the loan with excessive fees or pre-paid single premium credit life,
disability or other types of insurance polices
- Balloon payment
loans that force borrowers into costly future re-financings or
foreclosure situations
- Loan flipping, or the frequent
refinancing of a borrower that has the effect of stripping the
equity in the home
To run the risk of running afoul of Ben
Franklin's classic advice that smart men don't need advice and
fools don't take it, my advice is guarded. The tight rope that
must now be walked is one where a lender must be responsible and
make credit available at rates that reflect the costs and risks of
lending without engaging in abusive lending practices. This is
difficult since some of the characteristics that cause a borrower
to be a sub-prime borrower are also characteristics that may make
the customer vulnerable to predatory lending practices. However,
it is not a sine quo non that a sub-prime loan is always
predatory. Predatory as defined by Websters Dictionary means to
ensnare. In the lending context it is a lender that preys on a
borrower's weakness. After that definition, the demarcation line
between acceptable sub-prime lending and unacceptable blurs.
Clearly, standards must be established in order for lenders to
safely operate between encouraging lending in low income areas and
in denying such credit. Guidance must be established to preserve a
legitimate sub-prime lending environment as a resource to
residents who need it most. Without such clear guidance sub-prime
lenders have now been put in the position of grabbing their ankles
and praying.
Cohn, Goldberg and Deutsch Enters Into
Partnership Agreement With Domania.com
Last month, Cohn, Goldberg and Deutsch, LLC entered into an
agreement with Domania.com to provide real estate values to its
friends and clients. Individuals who place any United States
property address into the firm's web site link can obtain a
general idea of a property's value. Moreover, this feature can
also be used to discover multiple flips, where fraud is suspected.
DC Council Enacts
Drastic Foreclosure Law Re-Write
Last month, the
D.C. City Council enacted new legislation that will drastically
affect the manner that some foreclosures are conducted. As soon as
the Mayor signs it, the law will be enacted. His signature is
expected shortly. Once signed we will provide a summary of this
legislation in our next issue
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