White Paper: Federal Law

The Department of Financial Institutions (the Department) was created in 1993.

Federal Law and Predatory Lending

Here is a brief overview of the federal regulatory environment as related to home mortgages. These statutes provide effective but limited means to address predatory lending practices.

Real Estate Settlement Procedures Act ("RESPA"),
12 U.S.C. § 2601

Congress enacted RESPA primarily to prevent lenders from imposing excessive or abusive settlement charges on borrowers upon closure of any federally-related mortgage loan. The purpose of RESPA is to ensure lenders fully disclose all costs and fees associated with the loan. Under Section 8 of RESPA, borrowers may challenge any fees not "bona fide" - that is, those charges which are not directly related to goods or services received by the borrower. Examples of non-bona fide charges under Section 8 include kickbacks, referral fees, and unearned fees. 12 U.S.C. § 2607.

To identify a possible RESPA violation, the advocate must thoroughly review the client's settlement documents; specifically, the client's Good Faith Estimate ("GFE") and Uniform Settlement Statement ("HUD-1"). The format and organization of these documents is dictated by the Act.

The GFE is designed to make the borrower aware of the amount and range of charges related to the settlement of the transaction. These charges can include loan origination fees, fees charged by third parties like appraisal or title insurance fees, and other charges like property taxes or insurance. In most circumstances, the GFE must be provided within three days of application. The purpose of the GFE is to give the borrower an idea of the total closing costs associated with the loan and ostensibly to allow the borrower to shop around for a better price. However, the fees disclosed in the GFE need only be a good faith estimate (hence the name) and may change by the time the loan closes. 24 CFR § 3500.7.

The HUD-1 Settlement Statement is provided to the borrower upon the closing of the loan and sets forth the final settlement charges paid both to and by the borrower. These are the final charges associated with the loan and, as indicated above, they must be bona fide. 24 CFR § 3500.8.

When reviewing a client's loan documents for possible RESPA violations, the advocate should determine whether the GFE was provided within three days of the borrower's submission of the loan application to the lender, as is required by RESPA. The advocate should then compare the GFE and HUD-1; RESPA only requires the GFE bear a "reasonable" relationship to the final charges under HUD-1, with some allowance for variation. However, a GFE reflecting charges substantially lower than the HUD-1 may indicate predatory lending practices.

Ultimately, RESPA is a fairly ineffective tool to combat predatory lending as it provides for penalties and a right of action for violations of certain duties but not others. However, a lender's failure to provide proper disclosures required by RESPA should raise a red flag as to possible predatory practices and may give rise to potential causes of action under state law. A right of action under RESPA is available for the following: failure to provide servicing statement; failure to provide "controlled business arrangement" notice; failure to make timely payments out of escrow; failure to respond to qualified written request; failure to provide transfer of servicing statement; allowing kickbacks, fee splitting, and unearned fees; and requiring the purchase of title insurance from a certain title insurance company. 12 U.S.C. §§ 2605(f), 2607(d), 2608, 2614.

Home Ownership and Equity Protection Act ("HOEPA")
(or "Regulation Z", 12 CFR 226), 15 U.S.C. §§ 1602(aa), 1639

The Truth In Lending Act was amended in 1994 by HOEPA, which imposes additional disclosure requirements on lenders of certain high-cost loans. Those loans covered by HOEPA are closed-end mortgage refinance and home equity loans that charge either: (1) an APR of more than 10 percentage points above the yield on Treasury securities of comparable maturities; or (2) points and fees exceeding 8% of the loan amount or $400 (an inflation-adjusted amount1, approximately $451 in 2000), whichever is greater. 12 CFR § 226.32.

The existence of one of the two above conditions triggers the disclosures required by HOEPA. These disclosures are in addition to those required by TILA (above), and must be made in a conspicuous type size and provided to the borrower at least three days prior to closing.

The lender must disclose:

• the consumer is not required to complete the agreement even though an application has been signed;
  
  
• the transaction creates a mortgage on the consumer's home which could result in loss of the home and any equity therein should the borrower fail to pay according to the loan terms;
  
  
• the APR and amount of the monthly payment, including any balloon payment; and
  
  
• if the loan is a variable-rate loan and, if so, that the monthly payment may increase and the maximum monthly payment based on the maximum-allowed interest rate under the agreement.
  12 CFR § 226.32.

The Act also prohibits inclusion of the following terms in HOEPA-subject loans:

• prepayment penalties are generally prohibited except under very specific circumstances;
  
  
• the interest rate may not increase after default;
  
  
• a balloon payment is prohibited on a loan with a term of less than five years;
  
  
• the loan terms may not result in negative amortization; and
  
  
• the lender may not require the borrower prepay more than two periodic payments at closing.
  12 CFR § 226.32.

Additionally, and of great importance to advocates, HOEPA prohibits a lender from engaging in a pattern or practice of extending HOEPA loans without regard to the borrower's ability to repay from sources other than the encumbered home's equity. 12 CFR § 226.34.

Remedies available to borrowers where a HOEPA violation is present include all those under TILA, including rescission. In addition, where the lender's failure to comply with HOEPA is material, a borrower may recover an amount equal to the sum of all finance charges and fees paid in the transaction. 12 CFR § 226.23. Further, all claims and defenses that arise under any non-TILA, non-HOEPA theory against the original lender may be asserted against a subsequent purchaser or assignee of the loan.

Though the advocate should review the terms of a particular loan in order to determine whether HOEPA is applicable, it should be noted that many predatory lenders will impose costs and fees up to, but not exceeding, the HOEPA triggers. Further, HOEPA does not impose any limitation on up-front costs to the borrower, which provides an incentive to these lenders to engage in loan "flipping," which is also not prohibited by HOEPA.

Truth In Lending Act ("TILA")
15 U.S.C. § 1601

Where RESPA provides borrowers with information regarding loan settlement costs, TILA was enacted to provide borrowers with meaningful information about the credit transaction itself. Of most value to borrowers is the uniformity TILA imposes on creditors in the calculation of the Annual Percentage Rate ("APR"), which is designed to give borrowers the ability to comparison shop among lenders.

Under TILA, the lender is required to disclose the loan's finance charge, the APR, the amount financed, and the total of all payments.1 The finance charge is the total cost of the loan to the consumer, including principal, interest, and all other costs and fees. The APR must always be calculated using an annualized percentage rate. The disclosure is provided in a format mandated by the Act. 15 U.S.C. § 1605-1606. Here, a review of the HUD-1 Settlement Statement is indispensable in determining whether TILA has been violated. The advocate can review the itemized charges, calculate the amount financed and finance charges, and compare the resulting figure with the TILA disclosures.

TILA itself provides powerful remedies for borrowers. A borrower has an absolute right to rescind any non-purchase money mortgage transaction upon the occurrence of the latest of the following:

(1) within three days of closing;
(2) the giving of accurate material disclosures;
(3) or provision of the notice of the right to rescind.

The right to rescind must be communicated to the borrower in writing according to the regulations implementing the Act. The right to rescind extends up to three years from the date of either consummation of the transaction or sale of the property (whichever is earliest) if rescission is based only upon certain "material" violations of TILA. Upon a showing of a TILA violation, the borrower may bring an individual suit for statutory damages of twice the finance charge (capped at $2,000) plus consequential and incidental damages. 15 U.S.C. § 1635, 1640.

Though TILA is designed to provide consumers with fully disclosed financial information, thereby giving borrowers the ability to use credit in a more informed manner, this purpose is generally not achieved with respect to low-income and elderly populations. Numerous barriers exist for these borrowers, including poor education, settings for consumer bargaining not conducive to proper analysis of loan terms, language barriers, and a lack of opportunity to read disclosures before becoming psychologically committed to the contract. Thus, it is up to the advocate to carefully review the TILA disclosures for inaccuracies and omissions that might give rise to rescission rights within the three-year statute of limitations.

Fair Housing Act ("FHA"),
42 U.S.C. § 3601,
and Equal Credit Opportunity Act ("ECOA"), 15 U.S.C. § 1691

The Fair Housing Act, as amended, provides protections against housing-related discriminatory practices. It provides remedies for persons who experience predatory lending practices because of their race, color, national origin, religion, sex, disability, or parental status. These are "protected classes" under the law. The Act contains powerful tools that may be employed against lenders who engage in "reverse redlining" - that is, lending practices which target traditionally credit-starved minority communities with loan products with significantly higher interest rates and fees than those offered to non-minority communities.

In order to prevail in a FHA suit, the plaintiff may establish a prima facie claim through evidence of express discrimination by the lender, indirect evidence under a burden-shifting analysis, or through a disparate impact analysis. These theories of discrimination are briefly described below.

Express discrimination is shown through direct evidence of the lender's discriminatory intent. Direct evidence may include statements the lender makes in person, in advertising, or in any paperwork or internet materials which, on the face of the statement, shows discrimination.

Indirect evidence through burden shifting requires the plaintiff to show: (1) membership in a protected class; (2) application and qualification for a loan with defendant; (3) the loan offered contained patently unfavorable terms; and (4) defendant provided other borrowers possessing similar qualifications with loans on significantly better terms. McDonnell Douglas Corp. v. Green, 411 U.S. 792 (1973). If the plaintiff shows these elements, the burden shifts to the defendant to demonstrate some non-discriminatory, legitimate purpose behind the differential treatment.

Finally, discrimination proved through disparate impact requires a showing that defendant has a specific lending policy, procedure, or practice which results in a greater discriminatory impact on members of a protected class. Griggs v. Duke Power Co., 401 U.S. 424 (1971).

Where it can be demonstrated that predatory lending practices are based on the plaintiff's protected class status, the FHA provides potent remedies for plaintiffs. Under the Act, a plaintiff may obtain injunctive relief and compensatory damages, as well as attorneys' fees and costs. Punitive damages are also available.

Alternatively, ECOA prohibits any creditor from discriminating against any applicant with respect to any aspect of a credit transaction. 15 U.S.C. § 1691(a). This encompasses not only the application process and extension of credit, but to investigation procedures, terms of credit, collection procedures, and other matters as well. Thus, ECOA provides an additional legal theory under which a plaintiff may proceed with a claim of reverse redlining against a predatory lender.

Further discussion of the application of FHA and ECOA in the predatory lending context may be found in Hargraves v. Capital City Mortgage Corp., 140 F.Supp.2d 7 (D. D.C. 2000).

State and local fair housing statutes or ordinances may provide protected class status to more classes of persons. For example, in Washington State marital status is protected, and in Seattle and King County persons are protected from discrimination on the basis of their sexual orientation. Check your local laws.

The current inflation-adjusted figure may be obtained using an inflation calculator such as those available at http://www.jsc.nasa.gov/bu2/inflate.html