Definition of a “Creditor”

QUESTION 

We are a mid-size lender. I am the company’s Chief Compliance Officer. I do not believe a claim can be brought against a lender if the lender is not the creditor. We are no longer involved in the loan, having sold it. We do not own it, and we do not service it. 

Yet we are being caught up in litigation that alleges we have assignee liability. We are being forced to defend against a claim I do not think has merit. I would like some clarification about the meaning of the term “creditor” and whether assignee liability can reach us. 

What is the meaning of “creditor?” 

Do we have assignee liability? 

ANSWER 

My response will be somewhat limited without knowing more facts than you provided in your question. I strongly urge you to seek appropriate legal counsel with substantial experience in these matters. My reply is not meant to be taken as legal advice and does not infer same. Not all lawyers are sufficiently expert in issues like the one you describe. Faced with a lawsuit along these lines, you need an attorney who is an expert with considerable experience, not someone who is going to learn on the job. If you want a recommendation, please contact me separately here. 

I will offer a working definition of the term “creditor” under the Truth in Lending Act (TILA). Based on your question, I think TILA would be foundational to providing a worthwhile response. 

Regulation Z, the implementing regulation of TILA, defines the term “creditor” to mean: 

“A person (a) who regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments (not including a down payment), and (b) to whom the obligation is initially payable, either on the face of the note or contract, or by agreement where there is no note or contract.”[i] 

Courts often dismiss TILA claims filed against persons to whom the obligation is not initially payable (i.e., persons who are not “creditors”) as did a federal district court in Florida.[ii] This case, Walters v. Fast AC, may sound familiar to my lawyer friends and subscribers, as the U.S. Court of Appeals for the 11th Circuit previously considered a constitutional standing issue.[iii] Let’s drill down a little here because the case touches not only on the meaning of “creditor” but also the implications of assignee liability. 

I’ll sketch the case out in bullet points so we don’t get too entangled in the legalese. 

·       In 2018, an air conditioning technician for Fast AC, Mike, told Walters that the ductwork for his air conditioning unit needed to be replaced. 

o   When Walters hesitated about the cost, Mike assured him he could obtain financing. 

o   Mike then accessed Walters’ computer and e-signed several documents on Walters’ behalf, none of which Walters had a chance to read. 

o   Due to Mike’s actions, Walters “signed” a revolving account credit agreement with FTL Capital Partners, which contained TILA open-end disclosures. 

·       Walters called Fast AC to cancel the job before Walters paid any money and before Fast AC began any work. Fast AC said they could not help him. 

o   This left Walters with no immediate way of canceling the agreement because he had no idea who was financing the repairs. After he received his first bill, he called FTL to say the ductwork had been canceled. 

o   FTL refused to believe Walters because Fast AC had incorrectly represented that it had commenced work. 

·       Walters brought multiple claims, including TILA claims, against Fast AC and FTL. 

o   He claimed that his loan was a closed-end, not open-end, transaction for which he had received the wrong TILA disclosures. 

Ø  The district court dismissed the action, concluding that Walters lacked standing because he had not suffered any injury in fact. 

o   The 11th Circuit: 

§  sent the case back to the district court, holding that Walters had Article III standing to allege TILA disclosure violations because he had sufficiently alleged injury in fact.[iv] 

§  found that if Fast AC’s conduct were independent of FTL, then Walters’ injuries were not traceable to FTL, but concluded that Walters had “sufficiently pleaded that Fast AC was acting as FTL’s agent when it allegedly signed up Walters for a loan without disclosing the loan’s terms.” 

§  expressed no opinion on the merits of Walters’ claims, nor did it address whether or under what circumstances a creditor may be held liable under TILA for the actions of an agent or whether sufficient evidence showed an agency relationship between FTL and Fast AC. 

Ø  On remand, the district court examined Walters’ claim against FTL. 

§  Fast AC had become an FTL-licensed contractor in 2016 and was expelled in 2019 for falsely representing to FTL that it had completed installation work for customers. 

§  As mentioned above, in 2018, Fast AC contracted with Walters to replace HVAC ductwork. Walters sought to cancel the contract and eventually discovered that FTL had financed the deal. 

·       Walters asked the district court to consider his argument that his agreement with FTL was a closed-end transaction and FTL had violated TILA by only disclosing the information TILA required for open-end transactions. 

o   Walters contended that FTL should be vicariously liable for its agent’s (Fast AC’s) misconduct under TILA. 

Ø  Unfortunately for Walters, the court granted summary judgment for FTL. 

o   It concluded that FTL was not a “creditor” under TILA. 

§  As a result, the court did not need to consider whether a creditor might be liable for its agent’s misconduct under TILA or whether Fast AC had acted as FTL’s agent. 

Now, let’s go to the contract. The credit agreement had clearly indicated that FTL was a potential assignee by stating, for example, that the “Dealer may assign all rights under this Agreement and any credit sale…to FTL…” Thus, if the court construed the agreement as being initially payable to FTL, it would render this provision meaningless. 

The court also found that FTL was not liable as an assignee because whether the agreement with Fast AC reasonably contemplated repeated transactions was not apparent on the face of the documentation. Walters’ arguments that the loan was closed-end relied entirely on FTL’s corporate testimony and not anything on the face of the loan documents. 

As I stated above, unless the potential defendant is a “creditor” as defined in Regulation Z, such TILA claims generally cannot successfully be brought against the potential defendant. 

However, TILA specifically addresses assignee liability by providing: 

“Except as otherwise specifically provided in [TILA][v], any civil action for a violation [of TILA] or proceeding under [TILA § 108 by an enforcement agency][vi] which may be brought against a creditor may be maintained against any assignee of such creditor only if the violation for which such action or proceeding is brought is apparent on the face of the disclosure statement, except where the assignment was involuntary. For the purpose of this section, a violation apparent on the face of the disclosure statement includes, but is not limited to (1) a disclosure which can be determined to be incomplete or inaccurate from the face of the disclosure statement or other documents assigned, or (2) a disclosure which does not use the terms required to be used by [TILA].”[vii] 

It should also be mentioned that any consumer who has the right to rescind (i.e., right to cancel) a transaction under TILA may rescind the transaction as against any assignee of the obligation. 

To be classified as an “assignee,” the assignment must be voluntary on the part of the creditor. The assignee in an assignment for the benefit of creditors would not be coverable under TILA.[viii] As pointed out by the court, the definition of “creditor” plays an important role here: the creditor is the one to whom the obligation is initially payable on the face of the contract. Accordingly, as this court concluded, the seller in a credit sale contract assigned to a financial institution would be the “creditor,” while the financial institution would be the “assignee” under TILA.[ix] 

Note that the Home Ownership and Equity Protection Act (HOEPA) separately addresses assignee liability in connection with high-cost mortgage loans (HCMs is a term defined by Regulation Z).[x] HOEPA amended TILA to eliminate holder-in-due-course protections for purchasers and assignees of HCMs.[xi] Under TILA,[xii] consumers are entitled to assert against assignees all claims and defenses in connection with HCMs they could assert against creditors. 

To ensure that the assignee liability provision of HOEPA does not reach beyond HCMs, TILA insulates an assignee from liability if an assignee can demonstrate, by a preponderance of the evidence, that a reasonable person, exercising ordinary due diligence, could not determine the loan was an HCM after reviewing the loan documentation, the itemization of the amount financed, and other disclosure of disbursements.[xiii] The determination would require a review of the documentation required by TILA, including, but not limited to, the required disclosures and a disclosure of the disbursements or itemization of the amount financed. While the exception limits the liability of an assignee of an HCM, it was not intended to limit the liability under other TILA provisions. 

Indeed, to ensure that assignees are aware of their potential liability, TILA requires any party assigning an HCM to include a prominent notice of potential liability. Regulation Z[xiv] implements this requirement by specifying that a creditor may not sell or assign an HCM without furnishing the following statement to the purchaser or assignee: 

“Notice: This is a mortgage subject to special rules under the Federal Truth in Lending Act. Purchasers or assignees of this mortgage could be liable for all claims and defenses with respect to the mortgage that the consumer could assert against the creditor.” 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] §1026.(a)(17)(i)

[ii] Walters v. Fast AC, 2023 U.S. Dist. (M.D. Fla. October 24, 2023)

[iii] Walters v. Fast AC, 60 F.4th 642 (11th Cir. 2023)

[iv] Generally, for a party to establish Article III standing, he must allege (and ultimately prove) that he has a genuine stake in the outcome of the case because he has personally suffered (or will imminently suffer): (1) a concrete and particularized injury; (2) that is traceable to the allegedly unlawful actions of the opposing party; and (3) that is redressable by a favorable judicial decision. These requirements seek to ensure that federal courts do not exceed their Article III power to decide actual cases or controversies.

[v] See 15 USC §1635(c) of this title.

[vi] See 15 USC § 1607

[vii] TILA § 131; 15 U.S.C. § 1641

[viii] TILA § 131

[ix] Idem

[x] 12 CFR § 1023.32

[xi] Op. cit. vii

[xii] TILA § 131(d)

[xiii] Idem

[xiv] 12 CFR § 1023.34(a)(2)

Material Interference in UDAAP Lawsuit

QUESTION 

We are being sued for a violation of UDAAP. The lawsuit is based on the allegation that we materially interfered with the ability of a consumer to understand our terms and conditions. As far as I know, we have never intentionally misled a consumer. Our legal counsel is fighting back, but our reputation is already getting hit with negative press. 

I am the Chief Operating Officer, and with permission of our Board, I am writing you to ask for some history involving this kind of allegation. Your response could help us broaden our perspective and assist us in making sure this incident never happens again. 

We recently signed up for your UDAAP Tune-up, but it will not start for a few weeks. In the meantime, a word from you about some facets of this allegation would be appreciated. 

What is "material interference" involving terms and conditions in the context of UDAAP? 

ANSWER 

Thank you for your interest in our UDAAP Tune-up. Our UDAAP review is in demand. When it comes to Unfair, Deceptive, or Abusive Acts or Practices (UDAAP), it is essential to be proactive. Don’t wait for a regulatory investigation; certainly, don’t think you can wiggle your way out of a lawsuit, which often metastasizes into class action litigation. 

You can have your counsel contact me to discuss your case explicitly if they want expert witness support. 

There are many litigious access points to allege UDAAP violations, given that many regulatory frameworks are implicated.[i] You mentioned that you never intended to mislead the consumer; however, it is important to recognize that intent is not required to show material interference. 

Brief History

In 2010, Congress passed the Consumer Financial Protection Act of 2010 (CFPA) and banned abusive conduct.[ii] The CFPA's prohibition on abusive conduct was the most recent congressional tailoring of the Federal prohibitions to ensure fair dealing and protect consumers and market participants in the United States. 

The 2007-2008 financial crisis tested consumer protection laws, government watchdogs, and the ability of the existing authorities to address predatory lending, considered to be a primary cause of the collapse. The financial crisis was set in motion by avoidable interlocking forces. At its core were mortgage lenders profiting (by selling on the secondary market) on loans that set people up to fail because they could not repay. 

Consequently, Congress concluded that federal agencies' enforcement of the prohibitions on unfair and deceptive acts or practices was too limited to be effective at preventing the financial crisis. Therefore, it amended existing law. This is the point at which the FDIC, in 2007, said the term “unfairness” is a restrictive legal standard and the term “abusive” should be added because it is more legally flexible.[iii] In the CFPA, Congress granted authority over unfair or deceptive acts or practices to the states, the Federal banking agencies, and the newly created Consumer Financial Protection Bureau (CFPB). Congress also added a prohibition on abusive acts or practices. 

There have been numerous updates to the regulatory supervision and enforcement of UDAAP over the years. Indeed, since the enactment of the CFPA, government enforcement and supervisory agencies have taken dozens of actions to condemn prohibited abusive conduct. Earlier this year,  the CFPB issued a Policy Statement to summarize those actions and explain how the Bureau analyzes the elements of abusiveness through relevant examples. This Policy Statement is the CFPB’s first formal issuance that summarizes precedent on abusive acts or practices and provides an analytical framework for identifying abusive acts or practices.[iv] 

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For information about our UDAAP Tune-up, please contact us here.

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I will provide a cursory overview of the CFPA prohibitions. Thereafter, I’ll briefly explain the prohibition regarding “material interference” as it relates to terms and conditions.

Overview 

Under the CFPA, there are two abusiveness prohibitions.[v] An abusive act or practice: 

(1) Materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service, or 

(2) Takes unreasonable advantage of: 

·       A lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service; 

·       The inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service; or 

·       The reasonable reliance by the consumer on a covered person to act in the consumer's interests. 

The statutory text of these two prohibitions may be summarized at a high level as:

 

(1) obscuring important features of a product or service, or

 

(2) leveraging certain circumstances to take an unreasonable advantage. The circumstances, or three prongs, that Congress set forth generally concern gaps in understanding, unequal bargaining power, and consumer reliance.[vi] 

Unlike unfairness but similar to deception, abusiveness requires no showing of substantial injury to establish liability but is focused on conduct that Congress presumed to be harmful or distorts the proper functioning of the market. Put otherwise, an act or practice need only fall into just one of the categories above to be abusive, but an act or practice could fall into more than one category.[vii] 

Material Interference in Terms and Conditions 

The first abusive act or practice that takes unreasonable advantage of consumers, gaps in understanding, concerns situations where an entity “materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service.”[viii] Material interference may be shown when an act or omission is intended to impede consumers’ ability to understand terms or conditions, has the natural consequence of impeding consumers’ ability to understand, or actually impedes understanding. 

Acts or omissions may be material interference. Material interference may include actions or omissions that obscure, withhold, de-emphasize, render confusing, or hide information relevant to the ability of a consumer to understand terms and conditions. Interference can take numerous forms, such as “buried disclosures,” physical or digital interference, “overshadowing,” and various other means of manipulating consumers’ understanding. 

What is a buried disclosure? It is a disclosure that limits people’s comprehension of a term or condition, including, but not limited to, fine print, complex language, jargon, or the timing of the disclosure. There could be an oral component, too.[ix] Entities can also interfere with understanding by omitting material terms or conditions. 

There may be physical interference, where physical conduct impedes a person’s ability to see, hear, or understand the terms and conditions, including, but not limited to, physically hiding or withholding notices.[x] 

Digital interference may occur where there are impediments to a person’s ability to see, hear, or understand the terms and conditions when presented to someone in an electronic or virtual format. This form of interference includes, but is not limited to, user interface and user experience manipulations, such as the use of pop-ups or drop-down boxes, multiple click-throughs, or other actions or “dark patterns” that have the effect of making the terms and conditions materially less accessible or salient.[xi] 

Material interference includes a process of overshadowing, which is the prominent placement of certain content that interferes with the comprehension of other content, including terms and conditions.[xii] 

Facing Litigation 

There are several methods to prove material interference with a consumer’s ability to understand terms or conditions. My response focuses on the prong of leveraging certain circumstances to take unreasonable advantage of consumers, to wit, gaps in understanding, but the other two prongs, unequal bargaining power, and consumer reliance, may also be implicated in material interference litigation.     

First, while intent is not required to show material interference, it is reasonable to infer that an act or omission materially interferes with consumers’ ability to understand a term or condition when the entity intends it to interfere.[xiii] 

Second, material interference can be established with evidence that the act or omission's natural consequence would impede consumers’ ability to understand. 

And third, material interference can also be shown with evidence that the act or omission did, in fact, impede consumers’ actual understanding. 

While evidence of intent would provide a basis for inferring material interference under the first method, it is not a required element to show material interference. 

Certain transaction terms are so consequential that when not conveyed to people prominently or clearly, it may be reasonable to presume that the entity engaged in acts or omissions that materially interfere with consumers’ ability to understand. That information includes, but is not limited to, pricing or costs, limitations on the person’s ability to use or benefit from the product or service, and contractually specified consequences of default. 

An entity’s provision of a product or service may interfere with consumers’ ability to understand if the product or service is so complicated that material information about it cannot be sufficiently explained or if the entity’s business model functions in a manner that is inconsistent with the apparent terms of its products or services. 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

Servicer refutes being a Creditor

QUESTION 

We are servicing a loan portfolio of $2 billion. All we do is service loans belonging to lenders. We do not originate loans. 

Last week, we got a lawyer's letter that says we are a creditor. She represents the borrowers on a loan we service. She claims that we are responsible for errors in the escrow analysis. 

Our outside counsel tells us she doesn't have a case. He says we're not creditors. But he won't go into the details with us. I am the Compliance Manager. I may not be a lawyer, but I think I am entitled to an explanation. Hopefully, you can provide some feedback that we are not getting from our own lawyer. 

Is a servicer a creditor? 

ANSWER 

Let's start with a brief definition of the term "creditor." 

For purposes of our discussion here, the term "creditor" means a person who regularly extends credit that is subject to a finance charge or payable by a written agreement in more than four installments (not counting a down payment) and to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when no note or contract exists. 

In general, TILA imposes liability only on creditors for violations of its provisions. 

Some exceptions include the requirement that servicers provide notices of transfer or assignment of mortgage loans, certain obligations of loan originators,[i] and liability of assignees for violations apparent on the face of a disclosure statement, except when the assignment was involuntary.[ii] 

So, typically, a borrower who sues a defendant for violating TILA must tie the violation to the creditor (or, in the exceptions just mentioned, the servicer, loan originator, or assignee). 

A federal district court in Maryland recently addressed this requirement succinctly in Ayres v. PHH Mortgage Corp.[iii] 

In 1991, Ayres financed the purchase of a home by borrowing $72,660 from Market Street Mortgage Corporation. Ocwen became the loan servicer in 2011, and PHH took over servicing in 2019. Successive lawsuits followed, and Ayres entered into a loan modification agreement at some point. 

What made me think of this lawsuit is that, like your situation, disputes arose regarding the escrow account maintained in connection with the loan. 

In 2021, Ayres sued Ocwen, PHH, and the trustee for the securitization trust that held Ayres's loan, alleging that the defendants had engaged in misconduct related to the loan modification and overcharged the escrow account. 

Among other claims, Ayres alleged violations of the Home Ownership and Equity Protection Act (HOEPA, part of TILA) and Regulation Z. Importantly, Ayres alleged in her complaint that the trustee was the owner of the loan. 

The defendants moved to dismiss the HOEPA claim because: 

(1) they were not "creditors" under TILA;

(2) TILA, HOEPA, and Regulation Z do not apply to loan modifications;

(3) the loan modification was not a high-cost mortgage loan under TILA;

(4) the loan was not negatively amortized; and

(5) nothing in an existing consent order prohibited the loan modification. 

Ayres responded that: 

(1) the defendants were "creditors;"

(2) HOEPA applies to loan modifications;

(3) the mortgage loan under the modification agreement was a high-cost mortgage loan;

(4) the loan was negatively amortized; and

(5) Ocwen was not licensed under an applicable Maryland statute and, therefore, could not enter into the loan modification. 

The court dismissed the complaint because Ayres failed to allege that Ocwen had been involved with the origination of the loan or was the party to whom the loan was initially payable. Instead, Ayres simply alleged that Ocwen was the loan's servicer and that someone else was the owner or assignee. 

Thus, Ayres failed to state a claim because none of the defendants was a "creditor" within the meaning of TILA, which, by extension, disposed of the need to address items (2) through (5).

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] See 15 U.S.C. §1639b regarding duty of care and the prohibition of steering incentives.

[ii] 15 U.S.C. §1641(a)

[iii] Ayres v. PHH Mortgage Corp., 2022 U.S. Dist. (D. Md. Sept. 19, 2022)

Investor Owned Residential Loans: Risk Assessment

QUESTION

We are a mid-sized mortgage lender focused on investor-owned 1-4 family residential properties. Our underwriting and procedures are risk-based. In the last few years, we have grown considerably. I came on two years ago as the compliance manager. 

Last year, I retained a law firm to handle an audit to evaluate our procedures and overall risk-based audit program. In the end, I do not feel they did not consider important areas, such as underwriting standards, portfolio monitoring, capital treatment, and several qualitative factors. The audit objectives were not clearly defined. 

I am looking for some guidelines and remedies. If we have to do another audit, we do not want to spend as much money as we spent previously. Our policies and procedures are good, but I want more depth, especially because we are scaling up quickly. 

What audit objects and procedures should I consider in a risk assessment? 

ANSWER

There are lenders in the country whose sole or primary loan product involves financing investor-owned, 1-4 family residential properties. Our firm has such clients, and we work closely with them on their specific compliance needs. Most of them have risk-based programs that set up audit objectives and procedures. 

I suggest you contact us to discuss our IORR Tune-up®. The acronym “IORR” stands for “Investor Owned Residential Real Estate.” The intended purpose of the IORR Tune-up® is to promote consistent risk management practices for residential properties where the primary repayment source for the loan is rental income. The fee is probably a fraction of the cost you spent previously. The IORR Tune-up® will likely tell you the information you sought and does it in 60 days. 

For information about the IORR Tune-up®, Contact Us Here.

Lenders are authorized to make loans to investors to purchase or refinance 1-4 family residential real estate (“RRE”) properties for rental to others. Many lenders manage IORR financing like owner-occupied 1-4 family residential loans. However, the credit risk presented by IORR lending is more similar to that associated with loans for income-producing commercial real estate. Because of this similarity, regulators expect lenders to use the same types of credit risk management practices for IORR used for commercial real estate lending. (For banks, this expectation does not change the regulatory capital, regulatory reporting, or HOLA requirements for IORR.[i]) 

Your review should include at least the following audit objectives: 

·    Evaluate whether loan underwriting standards incorporate risks related to IORR loans. 

·    Understand methods for setting loan identification and portfolio monitoring expectations. 

·    Determine whether ALLL[ii] estimation procedures incorporate IORR loan risks and related qualitative factor adjustments, if applicable. 

·    Evaluate the adequacy of internal risk assessment and rating systems to monitor IORR credit risks effectively. 

·    Evaluate continued compliance with regulatory reporting, HOLA[iii], and risk-based capital treatment, if applicable. 

We spend considerable time keeping our clients aware of the federal and state laws and regulations relating to IORR transactions, especially the regulations that implement consumer protection laws, including ECOA, the Fair Housing Act, the Fair Credit Reporting Act, the Home Mortgage Disclosure Act, RESPA, HOEPA, TILA, and the Bank Secrecy Act. Management’s lending processes and origination platforms should ensure compliance with all applicable laws and regulations and provides timely and accurate disclosures to mortgage applicants. Mortgage loan originators and the lender’s staff must be diligent in safeguarding applicants’ and borrowers’ confidential information. 

Lenders and loan officers should provide sufficient information to customers so they fully understand material terms, costs, and risks of the loan products offered. Communication with customers, including advertisements, oral statements, and promotional materials, should provide clear and balanced information about the relative benefits and risks of mortgage loan products. 

Lenders Compliance Group has identified eighteen categories and questions that act as criteria for audit procedures. I will list them, so you can get a sense of how to build a due diligence assessment. The drill-down analysis is extensive. 

1.   Evaluate the institution’s credit risk management expectations for IORR loans. 

Know the risks! IORR has distinct and very different risks involved from traditional 1- to 4-family lending, such as the loans generally being repaid by rent and possibly some of the investor’s personal income, the investor possibly owning multiple properties, vacancies leading to lower revenue, and increased credit risk. 

Thus, it is essential to ensure appropriate policies and procedures suitable for the risks specific to IORR lending. These policies and processes should cover loan underwriting standards; loan identification and portfolio monitoring expectations; allowance for loan and lease losses (“ALLL”) methodologies, if applicable; and internal risk assessment and rating systems. 

2.   Identify if regulatory reporting, HOLA, and risk-based capital treatment are carried out properly.[iv] 

3.   Determine if IORR loans have been classified as residential or commercial. (If they are classified as residential, are they effectively managed as commercial loans?) 

4.   Does the institution exercise prudent underwriting due diligence similar to that required for commercial real estate loans? 

5.   Has an income producing property analysis been conducted? 

6.   Determine if loan structuring documents incorporate commercial-type provisions. 

7.   Are credit and administration issues being handled in a manner consistent with commercial real estate loans? 

8.   Is commercial real estate amortization guidance being followed? What guidelines are used? 

9.   Is guidance on multiple properties being followed? 

10.  Are subordination, non-disturbance, and attornment agreements obtained to cover the following issues? 

11.   Is subrogation considered in the loan agreement? 

12.  Are commercial vs. residential title issues adequately addressed? 

13.  Are loan identification and portfolio monitoring expectations adequately addressed? 

14.  Do internal risk assessment and rating systems include special consideration for IORR loans? 

15.  Does loan monitoring consider critical IORR loan issues, such as higher overall costs, smaller loan size, competition pricing like residential loans, appraisal timing, and environmental testing? 

16.  Have the IORR loans been factored into allowance for loan and lease losses considerations, if applicable? 

17.  Have IORR regulatory exam issues been adequately addressed, such as improper classification, risk rating reviews, LO monitoring, appraisal requirements, and borrower types? 

18.  Have secondary market issues been adequately addressed?

Violating TILA's High-Cost Provisions

QUESTION
We received a letter from the banking department that accuses us of violating high-cost mortgage provisions. This came from a review of 75 loan files, which they conducted remotely earlier this year. 

This is pretty scary for us. We are a small lender, licensed in only one state, and this kind of action has never happened. 

The violation specifically mentions the added provisions to the high-cost mortgage rule. We want to know more about these added provisions. 

Can you provide some information about the added provisions to the high-cost mortgage rule?

ANSWER
I understand that you are a bit upset about this situation. In my experience, banking departments do not go out of their way to “accuse” their licensees of violations. Generally, their orientation is geared toward consumer advocacy, and ensuring that supervision and enforcement are maintained across the range of companies in their purview. 

So, trust me, it’s very unlikely that you were singled out. This is just a banking department doing its job. Regulators want their licensees to operate within applicable federal and state guidelines.

Prior to the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), Regulation Z contained a set of restrictive provisions affecting high-fee, high-rate mortgage loans, which generally were referred to as HOEPA (Home Ownership and Equity Protection Act) or Section 32 mortgage loans (because the main provisions were found in Regulation Z § 1026.32).

The Dodd-Frank Act amended the Truth in Lending Act (TILA) to change the name to “high-cost mortgages” or HCMs, expand the scope of coverage, alter the coverage thresholds, and enhance the restrictions and prohibitions, but not until the CFPB amended Regulation Z (TILA’s implementing regulation), thereby promulgating the changes.

On January 13, 2013, the CFPB did just that, adopting its HCM Rule, also known as the January 2013 HOEPA Rule, with implementation delayed until January 10, 2014. Regulation Z requires special disclosures for HCMs and prohibits them from including certain provisions. In addition, consumers have enhanced remedies for violations, including rescission, higher damages, and higher potential liability for purchasers and assignees.

The HCM Rule added the following restrictions:

(1) a general ban of prepayment penalties and balloon payments, with limited exceptions including one for certain balloon loans made by creditors serving rural or underserved areas;

(2) a prohibition of fees for modifying HCMs;

(3) a cap on late fees of 4% of the past due payment;

(4) a prohibition of closing costs rolled into the loan amount;

(5) a restriction on the charging of payoff statement fees;

(6) a ban of certain other practices, such as encouraging a consumer to default on an existing loan to be refinanced by an HCM; and,

(7) a requirement of homeownership counseling before taking out an HCM; and (8) an enhanced requirement that creditors assess repayment ability.

Let me broaden this out a bit by discussing a recent decision in a federal district court in California, where TILA’s HCM provisions were applied. The case is Sundby v. Marquee Funding Group, Inc. [Sundby v. Marquee Funding Group, Inc., 2020 U.S. Dist. (S.D. Cal. Sept. 15, 2020)]

In 2016 and 2017, Sundby and his spouse obtained a loan and then refinanced it, obtaining both loans in the name of Sundby Trust, their family trust, and securing both with their home.

Sundby sued the two lenders for the same three alleged violations of TILA: (1) the inclusion of a prepayment penalty, (2) the inclusion of a balloon payment, and (3) a failure to abide by the ability-to-repay provisions.

After denying the lenders’ motions for summary judgment, the court granted summary judgment for Sundby.

The loans were HCMs because they required prepayment penalties exceeding 2 percent. TILA includes other ways of falling into the HCM category, but one automatic determinant is having a prepayment penalty exceeding 2 percent. The net result, then, is that the HCM violates TILA because it has a prepayment penalty.

The first loan contained a clause requiring the payment of a prepayment penalty equal to at least “90 days of interest from the day of this loan funding,” or $64,109.59, which amounted to more than 2 percent of the loan amount ($2,600,000) or $238,333.37. 

The second loan also carried a prepayment penalty of more than 2% because it required the payment of a prepayment penalty equal to “the difference between Six (6) month(s) of interest” and the interest due as of the “date of the prepayment” if “this loan [for $3,160,000] is paid off or refinanced during the first Six (6) month(s) of the term.” Given that the prepayment penalty could be as high as $150,100.02, it would exceed 2 percent of the loan amount.

This fact – having a prepayment penalty exceeding 2 percent – pushed the loans into the HCM category. It also meant that each loan violated TILA’s HCM prohibition of prepayment penalties.

The loans violated the HCM balloon payment prohibition because each loan required its entire principal and remaining interest due on a single day at the end of the loan and referred to that payment as a “balloon balance.”

The lenders also violated TILA by failing to adequately assess Sundby’s ability to repay. The applications for the loans did not include income or assets other than the subject property and listed only $7,200 monthly income, $5,840 expenses, $15,000 in non-property assets, and $40,000 in non-mortgage liabilities to service a $3,160,000 loan with $833.89 daily interest.

The parties included no additional evidence substantiating the lenders’ efforts to test or analyze Sundby’s ability to pay the loan. Given the lack of information available to the lenders, the lack of other evidence to indicate their due diligence, and the lenders’ failure to contest the ability to pay violation, the court granted summary judgment for Sundby as to the ability to repay.

So, what does this decision tell us? 

The case involved the restrictions and prohibitions that were added by the HCM Rule. 

Regulation Z already included, and still includes, other prohibitions, including prohibitions of negative amortization, advance payments, default interest rates, and non-actuarial rebates.

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group

HOEPA Loan Proceeds

QUESTION

We are a lender that originated a HOEPA loan. We were asked if we could make a payment to a contractor under a home improvement contract from HOEPA proceeds. Is that permissible?

ANSWER

A creditor may not pay a contractor under a home improvement contract from the proceeds of a HOEPA loan, other than:

1.     By an instrument payable to the consumer or jointly to the consumer and the contractor (and if there are multiple consumers who are primarily liable each must be named as payee); or

2.     At the election of the consumer, through a third-party escrow agent in accordance with the terms established in a written agreement signed by the consumer, the creditor, and the contractor prior to disbursement. [12 CFR § 226.34(a)(I); 12 CFR Supp. I to part 226 – Official Staff Commentary §226.34(a)(I)(i)-I]

Jonathan Foxx

President & Managing Director 

Lenders Compliance Group