Predatory lending practices are getting a lot of attention these days. It seems as if almost all the players in mortgage finance, from Fannie Mae and Freddie Mac on down, are beginning to scrutinize internal operations in terms of participation in making loans which may fall within the category of abusive loan practices.
Moreover, predatory lending practices, once less politely referred to as "loan sharking," have become priority agenda items for both federal and state lawmakers and regulators. North Carolina recently enacted a new law addressing predatory lending practices, and New York is considering similar legislation. In the District of Columbia, a Task Force assembled from a broad cross-section of special interest groups has been working on a comprehensive redraft of the D. C. law of mortgages, including abusive lending practices and foreclosure law, under the aegis of the D.C. Office of Banking and Financial Institutions. Competing bills on the subject have been introduced in Congress for the purpose of tightening the provisions of the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA) on high cost loans. The Office of Thrift Supervision has proposed changes in rules. And, a working group of Federal agencies is developing a policy statement on enforcement of federal fair lending and consumer protection laws that would serve as a warning and guidelines to lenders on acceptable lending practices for subprime loans. In partial response to these realized or pending initiatives, the Mortgage Bankers Association of America (MBA) recently released "best practices" guidelines on predatory lending and a policy statement supporting comprehensive reform of RESPA and TILA as the best form of consumer protection from predatory lending practices.
As Title News goes to press, the MBA Board has announced a seven point plan which includes comprehensive mortgage reform — including "guaranteed closing costs" as part of their recommendations for action on predatory lending.
Why All the Attention Now?
Why all the sudden focus on predatory lending? Claims handlers for title insurers can confirm that abusive lending practices have been around and causing claim losses for almost as long as title insurance has been around. After all, among the primary basic risks covered by a title insurance policy are fraud, forgery, and lack of legal capacity, all three of which have a tendency to go hand in hand with predatory lending practices.
To understand how this works, let’s take a look at the basic anatomy of a predatory loan. What will you find, as a rule, is a high cost loan made to an unsophisticated homeowner who does not have a lot of money or a steady income stream, but who does have substantial equity in his or her home. The primary objectives of the lender, and/or those involved in the loan process, are to collect extremely high loan fees up front, and ultimately, to force the borrower into default, so that the lender can foreclose and realize the borrower’s equity. Then the entire process, in many cases, can start all over again; subject, however, to the gradual decrease in the value of the home due to neglect, unpaid real property tax liens, and the like.
Most frequently, the targets of the predatory lenders are persons of limited education and the elderly. Neighborhoods are scouted for targets which meet the requisite criteria: unsophisticated borrowers with home equity who are in need of quick cash or home repairs. (Many of the predatory lending initiatives are tied into home improvement contracts under which little or no work is actually performed.) Not only are these targeted borrowers vulnerable by reason of their lack of business sophistication, but in many cases, until recently, their financial circumstances prevented them from qualifying for "mainstream" loans at reasonable rates.
The effect of these lending practices can be devastating, not only to victimized borrowers, but also in terms of the deterioration of entire urban neighborhoods. In the District of Columbia, large residential areas of the city once occupied by lower to middle income families with pride in their homes and in their neighborhoods have become virtually uninhabitable areas characterized by the presence of gun violence, drug dealing, and "squatters" living in derelict buildings. Predatory lending practices may not be the sole cause of this deterioration, but they have contributed to it substantially.
Two Recent Examples
Predatory lending practices are a source of substantial claims loss to title insurers. Two recent examples in the District of Columbia are representative both of the way abusive loan practices work, and the damage that they cause: in human terms, to the targeted borrowers, and in terms of claims losses, to title insurers.
In the Watson claim, claim was made under a First American Title Insurance Company loan policy issued on March 12, 1996, by an institutional lender who is a bulk purchaser of mortgages made by a local lender known for making high cost loans. The claimant foreclosed and, as successful bidder at the foreclosure sale, brought an action for possession. As a defense to this action, the conservator for the mortgagor, appointed by the Probate Division of the Superior Court of the District of Columbia about a year after the issuance of our title insurance policy, raised a plea of title, alleging that the insured mortgage was void by reason of the mortgagor’s incapacity at the time of his execution of same.
As our investigation of the facts of the claim proceeded, we discovered that the same local lender had made four consecutive loans to Mr. Watson, each refinancing the last. The first was made in July 1995 for $120,000. This loan was refinanced in October 1995 with a $209,000 loan from the same lender, in turn refinanced in February 1996 by a $225,400 loan. The last loan was made in March 1996 in the amount of $245,000.
Evidently Mr. Watson had fallen in with a purported home improvement contractor to whom he was supplying "capital" as an investor in the contractor’s business. The proceeds from the four loans were completely dissipated in this no-return investment.
Each loan cost Mr. Watson about $10,000 in fees and costs. His interest rate on each hovered around 12%. At the time the first loan was made, Mr. Watson was 85 years old, a retired federal employee with 47 years of civil service, who had lived in his home since 1935. It was unencumbered at the time the first loan was made, and according to his loan application, his unsecured debt was minimal. The home’s appraised value is $315,000.
By the time a claim was made under the title insurance policy, Mr. Watson’s conservator was represented by counsel acting pro bono, as Mr. Watson had no funds with which to pay an attorney.
How Was the Claim Resolved?
First American took a deed of the property from the foreclosing lender, in consideration of payment of policy limits. An agreement was reached between Mr. Watson and First American whereby he will remain in the property for six years as a tenant of First American, at a rent which covers basic maintenance only. He will also pay $500 per month into an escrow account. If Mr. Watson should die prior to the six-year period, the escrowed funds will go to First American. Otherwise, after he moves out of the house, which First American will then sell, he will be able to take an "annuity" from the funds to help subsidize his new living arrangements until the funds are exhausted, or until his death. This agreement serves Mr. Watson in enabling him to continue to live in his home, which is his primary desire, while affording some recovery to the title insurer.
The second example of a claim arising out of a predatory lending practice is quite new, and unresolved. The mortgagor, Mr. Roberts, represented by Legal Counsel for the Elderly, has filed suit to set aside a mortgage insured by First American on October 21, 1999.
The complaint was filed on March 28, 2000. In it, Mr. Roberts alleges that the defendants, consisting of the mortgage broker, the funding lender and its assignee, who is currently foreclosing, are seeking to foreclose on a loan created without the consent or even the knowledge of the borrower.
The borrower, described in the complaint as elderly, unsophisticated and with poor eyesight, has owned his home since 1974, free and clear until 1996. At that time he took out a $30,000 loan for home renovation with a 3-year term and a monthly payment of $311. In October 1999, he was contacted by the mortgage broker offering a replacement loan with lower payments. Mr. Roberts was then visited by an individual at his home, who had him sign papers described as a loan application. No copies of the papers were provided to Mr. Roberts.
In December 1999, Mr. Roberts received, by mail, a check for about $7,500. He also received a notice from his previous lender, with the return of his last mortgage payment check, stating that the loan was paid in full. The new loan is an ARM for $43,500 with an upward adjustment to 17.49% interest. His settlement charges were $4,816.46. He has sent back the proceeds check several times, and it has never been negotiated.
The complaint brought by Mr. Roberts alleges violations of TILA, the D.C. Interest Rate Ceiling Amendment Act, the D.C. Consumer Protections Procedure Act (recently held to apply to loan transactions by the D.C. Court of Appeals in DeBerry v. First Government Mortgage and Investors Corp.), 743 A.2d 699 (DC 1999), and the D.C. Mortgage Lenders and Brokers Act. Although matters arising from all of the foregoing laws may be excluded from coverage under Exclusion No. 5 of the ALTA® 1992 loan policy, a defense with reservation of rights has been afforded to the insured lender, based primarily on the insured closing letter issued for this transaction. The written loan closing instructions specify that the closing shall take place at the offices of the settlement company. In fact, the funding lender sent the loan package to the mortgage broker, who in turn requested that the loan be closed by an attorney not approved by the title insurer and engaged in an affiliated business arrangement with the mortgage broker. The settlement agent for whom the insured closing letter was issued merely prepared the title commitment and policy, and disbursed the funds, purportedly with the full knowledge of all parties.
This claim has not been fully investigated, and therefore any conclusion as to the truth of the facts alleged by the borrower is premature. Nevertheless, these facts fall within some of the standard parameters associated with predatory lending practices.
The Need for Reform
The growing concern of the mortgage finance industry, as well as state and federal legislators and regulators responding to consumer concerns, has resulted in a move towards reform of abusive lending practices and mortgage consumer protection law. The mortgage industry itself has begun the process of self-regulation. Freddie Mac recently announced that it would not purchase loans made in conjunction with the purchase by the borrower of a pre-paid single-premium credit life, credit disability, credit employment or credit property insurance policy, whether paid from the borrower’s funds or financed. Fannie Mae also has elected to issue guidelines on anti-predatory policies for the loans which it purchases, and the MBA has issued a policy statement supporting legislative solutions to abusive lending practices.
Unethical loan originators, who take advantage of borrowers on one end, and investors in the secondary market on the other, are becoming the targets of critical concern within the mortgage lending community, replacing a tacit "don’t ask, don’t tell" mentality.
Of equal importance are some fundamental changes in lending practices and underwriting criteria within the mortgage finance industry. With the recognition that someone with a less than perfect credit record may nevertheless be a good borrower, legitimate lenders are exploring the possibilities for profit in the sub-prime lending market, formerly the virtually exclusive purview of predatory lenders. The reverse mortgage is now an established product, enabling seniors to tap into their home equity as a source of income, without putting their financial security at risk. As a consequence, consumers whose bad credit or limited borrowing power may have once forced them to go to unscrupulous lenders now have access to viable financing options made available by legitimate lending sources.
As an Association, ALTA® appreciates the concerns that have prompted the introduction of the Predatory Lending Consumer Protection Act of 2000 (H.R. 4250; S. 2415) and other legislation on Capitol Hill. And we realize that predatory lending practices are a source of substantial claims loss to title insurers. In general, the Association supports reasonable legislative and regulatory action to address the problems and abuses that may exist with regard to "predatory" lending practices targeted at vulnerable consumers. We also recognize that there is a fine line between subprime and predatory lending, and that a legislative/regulatory solution to predatory lending practices will provide benefits to the title insurance industry in reduced foreclosures and claims.
Nevertheless, as Title News goes to press, the solutions under development by the Federal agencies seem to offer the most relief with the least burden for the title insurance industry.
Several federal agencies working together, most notably the Department of Housing and Urban Development, the Board of Governors of the Federal Reserve System, and the Department of Justice, are in the process of developing a "Policy Statement on Predatory Lending Practices." The Policy Statement addresses actions by lenders, including mortgage brokers issuers of credit cards, and secondary market entities. It provides guidance to companies through examples; similar to those cited above, of what may constitute predatory loan. The Policy Statement, in its current draft form, is a strong restatement of current law, and consequently creates a solution which benefits, but does not injure, the title insurance industry.
Congress Gets Involved
On Capitol Hill, on the other hand, ALTA® is concerned that some of the legislative proposals could actually create competitive and liability problems for the title insurance industry. Because we are clearly not central to the lending decisions, and only see the results of these loans at closing, or in limited situations where claims arise, we are limiting our comments to those provisions of the bills which directly affect the title insurance industry. We have three primary concerns.
First, several of the bills introduced in the Federal Congress reduce the thresholds for determining when loans are subject to the additional limitations and restrictions imposed by the HOEPA (Homeownership and Equity Protection Act) amendments to the Truth-in-Lending Act (TILA). HOEPA has always covered refinance loans and second mortgage liens, but has not covered loans used to purchase real estate. However, some of the new bills eliminate the current exclusion for "residential mortgage transactions." They significantly expand the definition of "high cost loans" and therefore the volume of loans that would be deemed "predatory." This may inadvertently reduce the availability of legitimate financing to low-income or less-than-prime borrowers. The concerns raised about predatory lending practices have related to refinance and second mortgage transactions. Consequently, ALTA® believes there is simply no reason to extend HOEPA to potentially millions of purchase money mortgage transactions in which there has been no evidence of the kind of abuses to which HOEPA is addressed Consequently, we do not believe that the current exclusion for "residential mortgage transactions" — transactions in which the loan is being used to acquire or construct the dwelling — contained in the current language of TILA § 103(aa)(1) should be eliminated.
Companion Bills a Major Focus
In addition, H.R. 4250 and S. 2415, the companion bills, eliminate a current provision of HOEPA that we believe should be retained. Under the current law, a second mortgage or loan refinance is subject to the HOEPA requirements if it bears a high annual percentage rate (i.e., more than 10 percentage points higher than the yield on Treasury securities having a comparable maturity) or if "the total points and fees payable by the consumer at or before closing will exceed the greater of (i) 8 percent of the total loan amount; or (ii) $400." /1 In determining what constitutes "points and fees" for purposes of this provision, HOEPA provides that certain settlement charges, including "[f]ees or premiums for title examination, title insurance, or similar purposes" are not included if the charge is reasonable; the creditor receives no direct or indirect compensation; and the charge is paid to a third party unaffiliated with the creditor./2
ALTA® believes that this current exclusion is both reasonable and appropriate. Some ALTA® members do participate in affiliated business arrangements, but we do understand the policy rationale behind the inclusion of affiliated business arrangement fees under current law. As the Senate Banking Committee report on the 1994 HOEPA legislation made clear, the purpose of imposing a trigger based on points and fees charged in the transaction was to "prevent unscrupulous creditors from using grossly inflated fees and charges to take advantage of unwitting customers." /3. On the other hand, if the lender is not benefiting from the charge, the charge is made by an unaffiliated third party, and the charge is reasonable, the charge does not affect in any way whether the loan is "predatory," and, as Congress correctly concluded in 1994, there is no reason why such charges should be included in determining the trigger for HOEPA coverage.
Unfortunately, H.R. 4250 and S. 2415, unlike the other bills that have been introduced on this subject, eliminates this aspect of HOEPA. In fact, the rationale for maintaining the current language is even stronger in light of the other changes made to HOEPA by H.R. 4250. H.R. 4250 and S. 2415 would modify the total amount of points and fees that triggers HOEPA coverage from 8% of the loan, or $400, whichever is higher, to 5% of the total loan amount, or $1,000, whichever is higher. The reduction from 8% to 5% would mean that, on a $50,000 refinance loan or second mortgage (for example), total fees and points of $2,500 would trigger HOEPA coverage, whereas under current law the total points and fees would have to exceed $4,000 before the loan would be deemed a "high-cost" loan triggering HOEPA coverage.
While Congress may conclude that this reduction is justified where the lender is pocketing the $2,500 in points and fees (and therefore may have an incentive to engage in equity stripping and repetitive refinancings), there is no justification in also eliminating the current exclusion for reasonable third-party charges in which the lender does not participate. Indeed, by reducing the trigger amount and eliminating that exclusion, H.R. 4250 and S.2415 risks converting many non-predatory, non-abusive loans into HOEPA-covered loans. This prospect could adversely affect the availability of financing to higher-risk borrowers.
Accordingly, we recommended to Congress that the section of the bill, to the extent that it deletes the current third-party charge exemption from the current Truth in Lending Act law, be changed to leave the current law in place. Moreover, we will work to ensure that Congress and the Federal regulators keep in mind that title insurance fees are regulated in most states, that these fees are based on costs and risk, and that adherence is required to ensure solvency and consumer protection.
TILA Provision a Concern
Our third concern relates to a new provision in TILA (§ 129(k)) that would be added by H.R. 4250, S.2415. The new provision would prohibit a creditor, in connection with a HOEPA-covered mortgage loan, from charging a borrower for credit insurance or a debt cancellation contract on a single premium basis through an up-front charge paid by the borrower at the outset of the loan. We express no views on whether such a prohibition is desirable or appropriate. What we are concerned about is that the language of the proposed legislation that states that "no creditor or other person may require or allow" the collection of such premiums. The "no . . . other person may . . . allow" language is unnecessary, ambiguous, and would set a questionable legislative precedent.
The language is unnecessary because the provision, without the additional words, would still prohibit lenders from collecting single premiums for credit insurance. The language is ambiguous, because it imposes obligations on unidentified "other persons" not to "allow" — whatever that means — lenders to collect such premiums. It has the potential for turning the title insurance and settlement services industry into a policeman for the transaction. Finally, it would set an unfortunate precedent for Congress, when it imposes direct obligations or requirements on particular parties (in this context, on lenders), to extend such obligations to "other persons" who may be deemed to have "allowed" an action to take place.
ALTA® members are involved in the closing of mortgage loans. Accordingly, we are concerned about impractical obligations being imposed on us because title companies who close loans or who issue title insurance policies to lenders might be viewed as "other persons" who have "allowed" the lender to obtain the single premium in connection with the transaction. Neither TILA, nor indeed other comparable consumer protection statutes, have sought to impose such obligations on third parties, and Congress should not start down that road in this bill. Further, in some states, mortgage loans are "net funded" and checks are not written for the lender items. There is no need for this additional language and we urged the Committee to delete the reference to "or other person" from the bill.
Finally, we note that H.R. 3901, the Schkawsky bill introduced in the House of Representatives, contains a provision referencing "conforming home loans (currently 240,000 or less)." That provision states that "a conforming home loan document in which blanks are left to be filled in after the contract is signed shall not be enforceable under Federal law or the law of any State." We believe this exclusion is overly broad. There should be room for correction of scrivenors errors in a Deed of Trust or Mortgage, and for filling in the recording information of a document referenced on an instrument which is not yet recorded, but will be recorded at or before the recording of the Deed of Trust/Mortgage.
In sum, while "predatory lending" will continue to be a source of concern and claims for the title insurance industry, it is important to ensure that any new legislation addressing these problems be clear and specific, and that such legislation does not inadvertently cause problems for the title insurance industry. Indeed, it is possible that the problems in this area can be addressed through enhanced action by the various federal agencies under existing law, without the need for new legislation. In any event, we are likely to see continued regulatory or legislative activity on this issue at the Federal and state levels, which could affect the industry in unforeseen ways.
1TILA, § 103(aa)(1).
2TILA, §§ 103(aa)(4)(C) and 106(e).
3S. Rep. 103-169 at 24 (1993).