T.I.L.A. Defense

Some of the T.I.L.A. Violations That Can Be Found In Mortgage Contracts.

 

 

15 Steps to Bring the Bank to the Bargaining Table

 

Truth In Lending Act Program Outline

(Each Mortgage is based on its own merits; your case may have more steps)

The following process is administrative. Each Mortgage is based on its own merits; you may have more steps and it may be necessary to go to court at additional expense.

Mortgage must have closed after September 30 1995, If before September 1995 it is recommended that you refinance.

1. Examine Mortgage documents for TILA violations (up to $2,000.00 in fines for each violation may be available)
2. Write rescission letter to Lender and Agents
3. Send rescission letter to Lender and Agents certified mail
4. Wait 20 business days for Lender and Agents to respond
5. Receive Lenders response (if any; usually the Lender defaults)
6. Write default letter to Lender and Agents
7. Send default letter to Lender and Agents certified mail
8. Write “Qualified Written Request”
9. Send  “Qualified Written Request” letter to Lender and Agents certified mail
10. Wait 60 business days
11. File complaint (lawsuit)
12. Lender may respond by sending many (300) pages of fluff. (stall tactics) In some cases Lender will make offer to settle
13. You negotiate to void Lenders security interest in the property and demand payment of violations fines and free and clear title. (all of these damages may not be available in your case)
14. Lender agrees
15. Security interest in the property is voided and you collect violation fines and Lender gives you free and clear title.

HIGHLIGHT:

Borrowers Have Successfully Sued Based on Allegations of Over-escrowing, Unauthorized Charges and Brokers’ Fees, Improper Private Mortgage Insurance Procedures, and Incorrectly Adjusted ARMS. The Author Analyzes Such Lending Practices, and the Litigation They Have Spawned.

 

BODY:

The current trends in litigation brought on behalf of  residential mortgage borrowers against mortgage originators and servicers.

The following types of litigation are discussed:(i) over-escrowing; (ii) junk charges; (iii) payment of compensation to mortgage brokers and originators by lenders; (iv) private mortgage insurance; (v) unauthorized servicing charges; and (vi) improper adjustments of interest on adjustable rate mortgages.

We have omitted discussion of abuses relating to high-interest and home improvement loans, a subject that would justify an article in itself.

OVER-ESCROWING

In recent years, more than 100 class actions have been brought against mortgage companies complaining about excessive escrow deposit requirements.

Requirements that borrowers make periodic deposits to cover taxes and insurance first became widespread after the Depression. There were few complaints about them until the late 1960s, probably because until that time many lenders used the ”capitalization” method to handle the borrowers’ funds. Under this method, escrow disbursements were added to the principal balance of the loan and escrow deposits were credited in the same manner as principal payments. The effect of this ”capitalization” method is to pay interest on escrow deposits at the note rate, a result that is fair to the borrower. When borrowers could readily find lenders that used this method, there was little ground for complaint.

The ”capitalization” method was almost entirely replaced by the current system of escrow or impound accounts in the 1960s and 1970s. Under this system, lenders require borrowers to make monthly deposits on which no interest is paid. Lenders use the deposits as the equivalent of capital by placing them in non-interest-bearing accounts at related banks or at banks that give ”fund credits” to the lender in return for custody of the funds. Often, surpluses greatly in excess of the amounts actually required to make tax and insurance payments as they came due are required. In effect, borrowers are required to make compulsory, interest-free loans to their mortgage companies.

One technique used to increase escrow surpluses is ”individual item analysis.” This term describes a wide variety of practices, all of which create a separate hypothetical escrow account for each item payable with escrow funds. If there are multiple items payable from the escrow account, the amount held for item A is ignored when determining whether there are sufficient funds to pay item B, and surpluses are required for each item. Thus, large surpluses can be built up. Individual item analysis is not per se illegal, but can readily lead to excessive balances.

During the 1970s, a number of lawsuits were filed alleging that banks had a duty to pay interest on escrow deposits or conspired to eliminate the ”capitalization” method. Most courts held that, in the absence of a statute to the contrary, there was no obligation to pay interest on escrow deposits. The only exception was Washington. Following these decisions, some 14 states enacted statutes requiring the payment of interest, usually at a very low rate.

Recent attention has focused on excessive escrow deposits. In 1986, the U.S. District Court for the Northern District of Illinois first suggested, in Leff v. Olympic Fed. S & L Assn. that the aggregate balance in the escrow account had to be examined in order to determine if the amount required to be deposited was excessive. The opinion was noted by a number of state attorneys general, who in April 1990 issued a report finding that many large mortgage servicers were requiring escrow deposits that were excessive by this standard. The present wave of over-escrowing cases followed.

Theories that have been upheld in actions challenging excessive escrow deposit requirements include breach of contract, state consumer fraud statutes, RICO, restitution, and violation of the Truth in Lending Act (”T.I.L.A.”). Claims have also been alleged under section 10 of the Real Estate Settlement Procedures Act (”RESPA”), which provides that the maximum permissible surplus is ”one-sixth of the estimated total amount of such taxes, insurance premiums and other charges to be paid on dates . . . during the ensuing twelve-month period.” However, most courts have held that there is no private right of action under section 10 of RESPA. Most of the over escrowing lawsuits have been settled. Refunds in these cases have totaled hundreds of millions of dollars.

On May 9, 1995, in response to the litigation and complaints concerning over-escrowing, HUD issued a regulation implementing section 10 of RESPA. The HUD regulation: 1. Provides for a maximum two-month cushion, computed on an aggregate basis (i.e., the mortgage servicer can require the borrower to put enough money in the escrow account so that at its lowest point it contains an amount equal to two months’ worth of escrow deposits) Does not displace contracts if they provide for smaller amounts; and Provides for a phase-in period, so that mortgage servicers do not have to fully comply until October 27, 1997.

Meanwhile, beginning in 1990, the industry adopted new forms of notes and mortgages that allow mortgage servicers to require escrow surpluses equal to the maximum two-month surplus permitted by the new regulation. However, loans written on older forms of note and mortgage, providing for either no surplus or a one-month surplus, will remain in effect for many years to come. In recent years, many mortgage originators attempted to increase their profit margins by breaking out overhead expenses and passing them on to the borrower at the closing. Some of these ”junk charges” were genuine but represented part of the expense of conducting a lending business, while others were completely fictional. By breaking out the charges separately and excluding them from the finance charge and annual percentage rate, lenders were able to quote competitive annual percentage rates while increasing their profits.

Most of these charges fit the standard definition of ”finance charge” under T.I.L.A.. A number of pre-1994 judicial and administrative decisions held that various types of these charges, such as tax service fees, fees for reviewing loan documents, fees relating to the assignment of notes and mortgages, fees for the transportation of documents and funds in connection with loan closings, fees for closing loans, fees relating to the filing and recordation of documents that were not actually paid over to public officials, and the intangible tax imposed on the business of lending money by the states of Florida and Georgia, had to be disclosed as part of the ”finance charge” under T.I.L.A..

The mortgage industry nevertheless professed great surprise at the March 1994 decision of the U.S. Court of Appeals for the Eleventh Circuit in Rodash v. AIB Mtge. Co., holding that a lender’s pass-on of a $ 204.00 Florida intangible tax and a $22.00 Federal Express fee had to be included in the finance charge, and that Martha Rodash was entitled to rescind her mortgage as a result of the lender’s failure to do so. The court found that ”the plain language of T.I.L.A. evinces no explicit exclusion of an intangible tax from the finance charge,” and that the intangible tax did not fall under any of the exclusions in REGULATION Z dealing with security interest charges. Claiming that numerous loans were subject to rescission under Rodash, the industry prevailed upon Congress and the Federal Reserve Board to change the law retroactively through a revision to the FRB Staff Commentary on REGULATION Z and the Truth in Lending Act Amendments of 1995, signed into law on September 30, 1995. The amendments:

1. Exclude from the finance charge fees imposed by settlement agents, attorneys, escrow companies, title companies, and other third party closing agents, if the creditor neither expressly requires the imposition of the charges nor retains the charges; 2. Exclude from the finance charge taxes on security instruments and loan documents if the payment of the tax is a condition to recording the instrument and the item is separately itemized and disclosed (i.e., intangible taxes); 3. Exclude from the finance charge fees for preparation of loan-related documents; 4. Exclude from the finance charge fees relating to pest and flood inspections conducted prior to closing; 5. Eliminate liability for overstatement of the annual percentage rate. 6. Increase the tolerance or margin of error; 7. Provide that mortgage servicers are not to be treated as assignees. The constitutionality of the retroactive provisions of the Amendments is presently under consideration.

The FRB Staff Commentary amendments dealt primarily with the question of third-party charges, and provided that they were not finance charges unless the creditor required or retained the charges.

The 1995 Amendments substantially eliminated the utility of T.I.L.A. in challenging ”junk charges” imposed by lenders. However, ”junk charges” are also subject to challenge under RESPA, where they are used as devices to funnel kickbacks or referral fees or excessive compensation to mortgage brokers or originators. This issue is discussed below.

”UPSELLING,” ”OVERAGES,” AND REFERRAL FEES TO MORTGAGE ORIGINATORS A growing number of lawsuits have been brought challenging the payment of ”upsells,” ”overages,” ”yield spread premiums,” and other fees by lenders to mortgage brokers and originators.

During the last decade it became fairly common for mortgage lenders to pay money to mortgage brokers retained by prospective borrowers. In some cases, the payments were expressly conditioned on altering the terms of the loan to the borrower’s detriment by increasing the interest rate or ”points.” For example, a lender might offer brokers a payment of 50 basis points (0.5 percent of the principal amount of the loan) for every 25 basis points above the minimum amount (”par”) at which the lender was willing to make the loan. Industry publications expressly acknowledged that these payments were intended to ”compensate mortgage brokers for charging fees higher than what the borrower would normally pay.” In other instances, brokers were compensated for convincing the prospective borrower to take an adjustable-rate mortgage instead of a fixed-rate mortgage or for inducing the purchase of credit insurance by the borrower.

In the case of some loans, the payments by the lender to the broker were totally undisclosed. In other cases, particularly in connection with loans made after the amendments to regulation X discussed below, there is an obscure reference to the payment on the loan documents, usually in terms incomprehensible to a lay borrower. For example, the HUD-1 form may contain a cryptic reference to a ”yield spread premium” or ”par plus pricing,” often abbreviated like ”YSP broker (POC) $ 1,500.”39

The burden of the increased interest rates and points resulting from these practices is believed to fall disproportionately on minorities and women. These practices are subject to legal challenge on a number of grounds.

Breach of Fiduciary Duty

Most courts have held that a mortgage broker is a fiduciary. One who undertakes to find and arrange financing or similar products for another becomes the latter’s agent for that purpose, and owes statutory, contractual, and fiduciary duties to act in the interest of the principal and make full disclosure of all material facts. ”A person who undertakes to manage some affair for another, on the authority and for the account of the latter, is an agent.”

Courts have described a mortgage loan broker as an agent hired by the borrower to obtain a loan. As such, a mortgage broker owes a fiduciary duty of the ”highest good faith toward his principal,” the prospective borrower. Most fundamentally, a mortgage broker, like any other agent who undertakes to procure a service, has a duty to contact a variety of providers and attempt to obtain the best possible terms.

Additionally, a mortgage broker ”is ‘charged with the duty of fullest disclosure of all material facts concerning the transaction that might affect the principal’s decision’.” The duty to disclose extends to the agent’s compensation. Thus, a broker may not accept secret compensation from adverse parties.

Furthermore, the duty to disclose is not satisfied by the insertion of cryptic ”disclosures” on documents. The obligation is to ”make a full, fair and understandable explanation” of why the fiduciary is not acting in the interests of the beneficiary and of the reasons that the beneficiary might not want to agree to the fiduciary’s actions.

The industry has itself recognized these principles. The National Association of Mortgage Brokers has adopted a Code of Ethics which requires, among other things, that the broker’s duty to the client be paramount. Paragraph 3 of the Code of Ethics states:

In accepting employment as an agent, the mortgage broker pledges himself to protect and promote the interest of the client. The obligation of absolute fidelity to the client’s interest is primary.

Thus, a lender who pays a mortgage broker secret compensation may face liability for inducing the broker to breach his fiduciary or contractual duties, fraud, or commercial bribery.

Definition: Breach of Fiduciary Duty

Mail/Fraud/ Wire Fraud/ R.I.C.O.

The payment of compensation by a lender to a mortgage broker without full disclosure is also likely to result in liability under the federal mail and wire fraud statutes and RICO. It is well established that a scheme to corrupt a fiduciary or agent violates the mail or wire fraud statute if the mails or interstate wires are used in furtherance of the scheme.

Real Estate Settlement Procedures Act (RESPA)

Irrespective of whether the broker or other originator of a mortgage is a fiduciary, lender payments to such a person may result in liability under section 8 of RESPA, which prohibits payments or fee splitting for business referrals, if the payments are either not fully disclosed or exceed reasonable compensation for the services actually performed by the originator.

Prior to 1992, the significance of section 8 of RESPA was minimized by restrictive interpretations. The Sixth Circuit Court of Appeals held that the origination of a mortgage was not a ‘’settlement service” subject to section 8.51 In addition; cases construing the pre-1992 version of implementing HUD regulation X required a splitting of fees paid to a single person. Finally, the payment of compensation in secondary market transactions was excluded from RESPA, and there was no distinction made between genuine secondary market transactions and ”table funded” transactions, where a mortgage company originates a loan in its own name, but using funds supplied by a lender, and promptly thereafter assigns the loan to the lender.

In 1992, RESPA and regulation X were amended to close each of these loopholes. The amendments did not have practical effect until August 9, 1994, the effective date of the new regulation X.

First, RESPA was amended to provide expressly that the origination of a loan was a ‘’settlement service.” P.L. 102-550 altered the definition of ‘’settlement service” in Section 2602(3) to include ”the origination of a federally related mortgage loan (including, but not limited to, the taking of loan applications, loan processing, and the underwriting and funding of loans).” This change and a corresponding change in regulation X were expressly intended to disapprove the Sixth Circuit’s decision in United States v. Graham Mtge. Corp.

Second, regulation X was amended to exclude table funded transactions from the definition of ‘’secondary market transactions.” Regulation X addresses ”table funding” in sections 3500.2 and 3500.7. Section 3500.2 provides that ”table funding means a settlement at which a loan is funded by a contemporaneous advance of loan funds and an assignment of the loan to the person advancing the funds. A table-funded transaction is not a secondary market transaction (see Section 3500.5(b) (7)).” Section 3500.5(b) (7) exempts from regulation by RESPA fees and charges paid in connection with legitimate ‘’secondary market transactions,” but excludes table funded transactions from the scope of legitimate secondary market transactions. Under the current regulation X, RESPA clearly applies to table funded transactions. Amounts paid by the first assignee of a loan to a ”table funding” broker for ”rights” to the loan — i.e., for the transfer of the loan by the broker to the lender — are now subject to examination under RESPA.

Third, any sort of payment to a broker or originator that does not represent reasonable compensation for services actually provided is prohibited.

Whatever the payment to the originator or broker is called, it must be reasonable. Another mortgage industry publication states: Any amounts paid under these headings [servicing release premiums or yield spread premiums] must be lumped together with any other origination fees paid to the broker and be subjected to the referral fee/ market value test in Section 8 of RESPA and Section 3500.14 of Regulation X. If the total of this compensation exceeds the market value of the services performed by the broker (excluding the value of the referral), then the compensation does not pass the test, and both the broker and the lender could be subject to the civil and criminal penalties contained in RESPA.

Normal compensation for a mortgage broker is about one percent of the principal amount of the loan. Where the broker ”table funds” the loan and originates it in its name, an extra .5 percent or one percent may be appropriate. This level of reasonableness is recognized by agency regulations. For example, on February 28, 1996, in response to allegations of gouging by brokers on refinancing VA loans, the VA promulgated new regulations prohibiting mortgage lenders from charging more than two points in refinanced transactions.

The amended regulation makes clear that a payment to a broker for influencing the borrower in any manner is illegal. ”Referral” is defined in Section 3500.14(f) (1) to include ”any oral or written action directed to a person which has the effect of affirmatively influencing the selection by any person of a provider of a settlement service or business incident to or part of a settlement service when such person will pay for such settlement service or business incident thereto or pay a charge attributable in whole or in part to such settlement service or business. . . .” The amended regulation also cannot be evaded by having the borrower pay the originator. An August 14, 1992 letter from Frank Keating, HUD’s General Counsel, states unequivocally: ”We read ‘imposed upon borrowers’ to include all charges which the borrower is directly or indirectly funding as a condition of obtaining the mortgage loan. We find no distinction between whether the payment is paid directly or indirectly by the borrower, at closing or outside the closing. . . . I hereby restate my opinion that RESPA requires the disclosures of mortgage broker fees, however denominated, whether paid for directly or indirectly by the borrower or by the lender.”

Thus, ”yield spread premiums,” ‘’service release fees,” and similar payments for the referral of business are no longer permitted. The new regulation was specifically intended to outlaw the payment of compensation for the referral of business by mortgage brokers, either directly or through the imposition of ”junk charges.” Thus, it provides that payments may not be made ”for the referral of settlement service business” (Section 3500.14(b)).

The mortgage industry has recognized that types of fees that were once viewed as permissible in the past are now ”prohibited and illegal.” The legal counsel for the National Second Mortgage Association acknowledged: ”Even where the amount of the fee is reasonable, the more persuasive conclusion is that RESPA does not permit service release fees.” ”Also, if . . . the lender is ‘table funding’ the loan, he is violating RESPA’s Section 8 anti-kickback provisions.”

In the first case decided under the new regulation, Briggs v. Countrywide Funding Corp., the U. S. District Court for the Middle District of Alabama denied a motion to dismiss a complaint alleging the payment of a ”yield spread premium” by a lender to a broker in connection with a table funded transaction. Plaintiffs alleged that the payment violated RESPA as well as several state law doctrines. The court acknowledged that RESPA applied to the table funded transactions and noted that whether or not disclosed, the fees could be considered illegal.

Truth in Lending Act Implications Many of the pending cases challenging the payment of ”yield spread premiums” and ”upselling” allege that the payment of compensation to an agent of the lender is a T.I.L.A. ”finance charge.” The basis of the T.I.L.A. claims is that the commission a borrower pays to his ”broker” is a finance charge because the ”broker” is really functioning as the agent of the lender. The claim is not that the ”upsell” payment made by the lender to the borrower’s broker is a finance charge.

Decisions under usury statutes uniformly hold that a fee charged to the borrower by the lender’s agent is interest or points.  64 The concept of the ”finance charge” under T.I.L.A. is broader than, but inclusive of, the concept of ”interest” and ”points” at common law and under usury statutes. REGULATION Z specifically provides that the ”finance charge” includes any ”interest” and ”points” charged in connection with a transaction. 65 Therefore, if the intermediary is in fact acting on behalf of the lender, as is the case where the intermediary accepts secret compensation from the lender or acts in the lender’s interest to increase the amount paid by the borrower, all compensation received by the intermediary, including broker’s fees charged to the borrower, are finance charges.

Unfair and Deceptive Acts and Practices The pending ”upselling” cases also generally allege that the payment of compensation to the mortgage broker violates the general prohibitions of most state ”unfair and deceptive acts and practices” (”UDAP”) statutes. The violations of public policy codified by the federal consumer protection laws create corresponding state consumer protection law claims.

Civil Rights and Fair Housing Laws The Department of Justice brought two cases in late 1995 alleging that the disproportionate impact of ”overages” and ”upselling” on minorities violated the Fair Housing Act and Equal Credit Opportunity Act. Both cases alleged disparate pricing of loans according to the borrower’s race and were promptly settled. Other investigations are reported to be pending. The principal focus of enforcement agencies appears to be on the civil rights implications of overages.

It is likely that such a practice would also violate 42 U.S.C. Section 1981. While Section 1981 requires intentional discrimination, a lender that decides to take advantage of the fact that other lenders discriminate by making loans to minorities at higher rates is also engaging in intentional discrimination. In Clark v. Universal Builders, the Seventh Circuit held that one who exploits and preys on the discriminatory hardship of minorities does not occupy a more protected status than the one who created the hardship in the first instance; that is, a defendant cannot escape liability under the Civil Rights Act by asserting it merely ”exploited a situation crated by socioeconomic forces tainted by racial discrimination.”

PRIVATE MORTGAGE INSURANCE LITIGATION Another group of pending lawsuits is based on claims of misrepresentation of or failure to disclose the circumstances under which private mortgage insurance (”PMI”) may be terminated. PMI insures the lender against the borrower’s default — the borrower derives no benefit from PMI. It is generally required under a conventional mortgage if the loan to value ratio exceeds about 80 percent. Approximately 17.4 percent of all mortgages have PMI.

Standard form conventional mortgages provide that if PMI is required it maybe terminated as provided by agreement. Most servicers and investors have policies for terminating PMI. However, the borrower is often not told what the policy is, either at the inception of the mortgage or at any later time. As a result, people pay PMI premiums unnecessarily. Since there is about $ 460 billion in PMI in force, this is a substantial problem. The failure accurately and clearly to disclose the circumstances under which PMI may be terminated has been challenged under RICO and state consumer fraud statutes.

UNAUTHORIZED SERVICING CHARGES Another fertile ground of litigation concerns the imposition of charges that are not authorized by law or the instruments being serviced. The collection of modest charges is a key component of servicing income. For example, many mortgage servicers impose charges in connection with the payoff or satisfaction of mortgages when the instruments either do not authorize the charge or affirmatively prohibit it.

The imposition of payoff and recording charges has been challenged as a breach of contract, as a deceptive trade practice, as a violation of RICO, and as a violation of the Fair Debt Collection Practices Act (”FDCPA”). In Sandlin v. State Street Bank, the U. S. District Court for the Middle District of Florida held that the imposition of a payoff statement fee is a violation of the standard form ”uniform instrument” issued by the Federal National Mortgage Association and Federal Home Loan Mortgage Corporation, and when imposed by someone who qualifies as a ”debt collector” under the FDCPA, violates that statute as well. However, attempts to challenge such charges under RESPA have been unsuccessful, with courts holding that a charge imposed subsequent to the closing is not covered by RESPA.

The Fair Debt Collection Practices Act

Adjustable rate mortgages Adjustable rate mortgages (”ARMs”) were first proposed by the Federal Home Loan Bank Board in the 1970s. They first became widespread in the early 1980s. At the present time, about 25 to 30 percent of all residential mortgages are adjustable rate mortgages (”ARMs”).

The ARM adjustment practices of the mortgage banking industry have been severely criticized because of widespread errors. Published reports beginning in 1990 indicate that 25 to 50 percent of all ARMs may have been adjusted incorrectly at least once. The pattern of mis-adjustments is not random: approximately two-thirds of the inaccuracies favor the mortgage company.

Grounds for legal challenges to improper ARM adjustments include breach of contract, T.I.L.A., the Uniform Consumer Credit Code, RICO, state unfair and deceptive practices statutes, failure to properly respond to a ”qualified written request” under section 6(e) of RESPA, and usury.

Substantial settlements of ARM claims have been made by Citicorp Mortgage, First Nationwide Bank, and Banc One. On the other hand, several cases have rejected borrower claims that particular ARM adjustment actions violated the terms of the instruments. For example, a Connecticut case held that a mortgage that provided for an interest rate tied to the bank’s current ”market rate” was not violated when the bank failed to take into account the rate that could be obtained through the payment of a ”buydown.” A Pennsylvania case held that the substitution of one index for another that had been discontinued was consistent with the terms of the note and mortgage.

A major issue in ARM litigation is whether what the industry erroneously terms ”undercharges” — the failure of the servicer to charge the maximum amount permitted under the terms of the instrument — can be ”netted” or offset against overcharges — the collection of interest in excess of that permitted under the terms of the instrument. Fannie Mae has taken the position that ”netting” is appropriate.

The validity of this conclusion is questionable. First, nothing requires a financial institution to adjust interest rates upward to the maximum permitted, and there are in fact often sound business reasons for not doing so. On the other hand, the borrower has an absolute right not to pay more than the instrument authorizes. Thus, what the industry terms an ”undercharge” is simply not the same thing as an ”overcharge.”

Second, the upward adjustment of interest rates must be done in compliance with T.I.L.A.. An Ohio court held that failure to comply made the adjustment unenforceable. ”Where a bank violates the Truth-in-Lending Act by insufficient disclosure of a variable interest rate, the court may grant actual damages. . . . If the actual damage is the excess interest charge over the original contract term, the court may order the mortgage to be recalculated at its original terms, and refuse to enforce the variable interest rate provisions.”

Third, if the borrower is behind in his payments, ”netting” may violate state law requiring the lender to proceed against the collateral before undertaking other collection efforts. A decision of the California intermediate appellate court concluded that the state’s ”one-action rule” had been violated when a lender obtained an offset of interest overcharges against amounts owed by the borrower under an ARM.